Mr. Kalyan Nath, IRS (IT: 2001)
Addl. CIT, Range 13, Kolkata
kalyan.nath@incometax.gov.in

Mr. Kalyan Nath

More than 25 year of experience as an officer of Income Tax Department in various departments including  Investigation, Central ,Corporate ,TDS and Transfer Pricing charges. Regular visiting faculty of DTRTI, Kolkata and Visiting Sr. DR of ITAT, Kolkata. Received appreciation letters for Contribution in TDS as well as DTRTI, Kolkata. Was Member of contributors for “Investigation Manual” and TPO manual on “Financial Transactions”.

Executive Summary

Taxation of share premium is a relatively new but litigated area of taxation. This article examines the two alternative approaches the AO should adopt while examining the issue where share premium received is in excess of its fair market value, i.e. the route of Section 68 or Section 56 (2)(viib).

Several case laws on the issue has been presented for better appreciation by the readers. Towards the end, the issue of angel tax which occupied quite a space in the public discourse till recently, has also been touched upon.

Share Premium

The assessment of share premium is always a contentious issue. Subscription received with huge premium, is a common issue in company assessments. The AO can verify the source of the subscription and also can apply the yardstick of Sec 56(2)(viib) of Income Tax Act 1961. In this article,we will look into the legal issues in invoking the provisions of Sec 56(2)(viib) of Income Tax Act 1961. The relevant portion of law is reproduced below.

RELATED PROVISIONS IN THE INCOME TAX ACT AND INCOME TAX RULE

Income from other Sources

56. (1) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in Section 14, items A to E.

(2) In particular, and without prejudice to the generality of the provisions of Sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely:—

………

(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:

Provided that this clause shall not apply where the consideration for issue of shares is received—

i. by a venture capital undertaking from a venture capital company or a venture capital fund 67[or a specified fund]; or

ii. by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

Following second proviso shall be inserted after the existing proviso to clause (viib) of Sub-section (2) of Section 56 by the Act No. 23 of 2019, w.e.f. 1-4-2020:

Provided further that where the provisions of this clause have not been applied to a company on account of fulfilment of conditions specified in the notification issued under clause (ii) of the first proviso and such company fails to comply with any of those conditions, then, any consideration received for issue of share that exceeds the fair market value of such share shall be deemed to be the income of that company chargeable to income-tax for the previous year in which such failure has taken place and, it shall also be deemed that the company has under-reported the income in consequence of the misreporting referred to in Sub-section (8) and Sub-section (9) of Section 270A for the said previous year. Explanation.—For the purposes of this clause,—

a. the fair market value of the shares shall be the value—

i. as may be determined in accordance with such method as may be prescribed; or

ii. as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,

whichever is higher;

Following clauses (aa) and (ab) shall be inserted after clause (a) of Explanation to clause (viib) of Sub-section (2) of Section 56 by the Act No. 23 of 2019, w.e.f. 1-4-2020:

(aa) “specified fund” means a fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which has been granted a certificate of registration as a Category I or a Category II Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012 made under the Securities and Exchange Board of India Act, 1992 (15 of 1992);

(ab) “trust” means a trust established under the Indian Trusts Act, 1882 (2 of 1882) or under any other law for the time being in force;

b. “venture capital company”, “venture capital fund” and “venture capital undertaking” shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause (23FB) of Section 10;

Clause (viib) of Sub-section (2) of Section 56 was inserted vide finance act, 2013 wef 01.04.2013 i.e for A.Y. 2013-14 to provide that where a closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares will be charged to tax in the hand of the company as income from other sources. This amendment was made keeping in view the practice of closely held companies to bring undisclosed money of promoters/directors by issuing shares at high premium which is normally over and above the book value of share of the company, and moreover which escaped the provisions of Section 68. Moreover, in case of many closely held companies and even in new companies promoter used to issue share at premium with the main purpose of keeping share capital low, yet capital base stronger so that breakup value and market value is high. This leads to advantage of low cost of servicing share captial and also improved prospects to issue share at premium In future by way of initial issue of offering by promoters. One more practical advantage was to save on account of cost of fees payable on increase of authorized capital. When shares are issued at premium, number of shares and authorized capital increase lesser in comparison of capital raised by way of capital and premium. These provisions are deeming provisions as otherwise share premium and capital arecapital receipts which cannot be taxed as income.However, w.e.f. A.Y. 2013-14 for closely held companies share premium or share capital is deemed to be normal income if shares are issued exceeding fair market value of shares.

The valuation rules are specified under Ruule11UA, Rule 11UAA and Rule 11UB for various provisions under the Income-tax Act, 1961(the “Act”) which cover valuation options in case of various assets including equity shares and other securities. These rules specify the methodology to be adopted at the time of arriving at fair market value in different scenarios and also the eligible person who can issued such valuation report. Among the various provisions of the Act, the provisions u/s 56(2)(viib) states that where a company other than a company in which public are substantially interested, issue shares at more than fair market value to a resident person, then differential value between such issue price and fair market value will be considered as income for such company under provision of Section 56(2)(viib) of the Act.

DETERMINATION OF FAIR MARKET VALUE

11UA. [(1)] For the purposes of Section 56 of the Act, the fair market value of a property, other than immovable property, shall be determined in the following manner, namely,—

a. valuation of jewellery,—

i. the fair market value of jewellery shall be estimated to be the price which such jewellery would fetch if sold in the open market on the valuation date;

ii. in case the jewellery is received by the way of purchase on the valuation date, from a registered dealer, the invoice value of the jewellery shall be the fair market value;

iii. in case the jewellery is received by any other mode and the value of the jewellery exceeds rupees fifty thousand, then assessee may obtain the report of registered valuer in respect of the price it would fetch if sold in the open market on the valuation date;

b. valuation of archaeological collections, drawings, paintings, sculptures or any work of art,—

i. the fair market value of archaeological collections, drawings, paintings, sculptures or any work of art (hereinafter referred as artistic work) shall be estimated to be price which it would fetch if sold in the open market on the valuation date;

ii. in case the artistic work is received by the way of purchase on the valuation date, from a registered dealer, the invoice value of the artistic work shall be the fair market value;

iii. in case the artistic work is received by any other mode and the value of the artistic work exceeds rupees fifty thousand, then assessee may obtain the report of registered valuer in respect of the price it would fetch if sold in the open market on the valuation date;

c. Valuation of shares and securities,—

a. the fair market value of quoted shares and securities shall be determined in the following manner, namely,—

i. if the quoted shares and securities are received by way of transaction carried out through any recognized stock exchange, the fair market value of such shares and securities shall be the transaction value as recorded in such stock exchange;

ii. if such quoted shares and securities are received by way of transaction carried out other than through any recognized stock exchange, the fair market value of such shares and securities shall be,—

a. the lowest price of such shares and securities quoted on any recognized stock exchange on the valuation date, and

b. the lowest price of such shares and securities on any recognized stock exchange on a date immediately preceding the valuation date when such shares and securities were traded on such stock exchange, in cases where on the valuation date there is no trading in such shares and securities on any recognized stock exchange;

b. 1the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner, namely:—

the fair market value of unquoted equity shares = (A+B+C+D – L)× (PV)/(PE), where,

A = book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance-sheet as reduced by,—

i. any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and

ii. any amount shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

B = the price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

C = fair market value of shares and securities as determined in the manner provided in this rule;

D = the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property;

L= book value of liabilities shown in the balance sheet, but not including the following amounts, namely:—

i.  the paid-up capital in respect of equity shares;

ii.  the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

 iii. reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

iv. any amount representing provision for taxation, other than amount of income-tax paid, if any, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

v.  any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

vi.  any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PV = the paid up value of such equity shares;

PE = total amount of paid up equity share capital as shown in the balance-sheet;]

c. the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of which such valuation. 

[(2) Notwithstanding anything contained in sub-clause (b) of clause  (c) of sub-rule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of Sub-section (2) of Section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:—

a. the fair market value of unquoted equity shares =

where,

A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortized amount of deferred expenditure which does not represent the value of any asset;

L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:—

i.  the paid-up capital in respect of equity shares;

ii.  the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

iii.  reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

iv.  any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

v.  any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

vi.  any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PE = total amount of paid up equity share capital as shown in the balance-sheet;

PV = the paid up value of such equity shares; or

b.  the fair market value of the unquoted equity shares determined by a merchant banker 2[***] as per the Discounted Free Cash Flow method.]

The methodology to be adopted for the purpose of arriving at the fair valuation of such shares under this Section has been specifically stated under rule 11UA(2) separately for equity shares and shares other than equity shares. Sub clause (b) under this sub-rule states that the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the asessee may obtain a report from a merchant banker or a Chartered Accountant in respect of such valuation. This has been amended vide Notification No. 23/2018- Income Tax dated 24 May 2018 by CBDT which stated as follows:

1. In the Income-tax Rules, 1962(hereinafter referred to as the principal rules), in rule 11U, clause (a) shall be omitted

2. In the principal rules, in rule 11UA, in sub-rule(2), in clause(b), the words “or an accountant” shall be omitted.

The word accountant has been omitted under Rule 11U and Rule 11UA(2)(b) which implies  that for the purpose of Section 56(2)(viib), in case of shares other than equity shares, the fair valuation certified by only merchant bankers will be valid after the date of publishing of such notification.

The Net Asset Value(NAV) method is very straight forward and uncomplicated method for share valuation.

Therefore, in a number of cases the assessee prefers Discounted Free Cash Flow method to substantiate the share valuation. Since this method depends upon future revenue projections, the assessee indulges into various assumptions, which may be wrong and/or impossible The data are generally supplied by the asseseee to the valuer, who on the basis of such fictitious figures prepares projection in favour of the assessee. Common methods are

1. Projected income not commensurate with current trend of businesss.

2. No empirical data to support the industry future or trend

3. Projection ofsubstantial income from non core business

4. Suppression of expenditure in projection

5. The GP/NP ratio not in tandem with the industry/line of business etc.

A new company, particularly in the service sector does not have sufficient capital base at the inception and hence NAV method sometimes becomes impractical to apply. Due to this reason, lot of companies adopt DCF method which requires lot of subjective analysis in terms of revenue projections, adoption of discounting factor, risk free rate of interest, inflation rate, etc.

IS IT A GENUINE TRANSACTION

Now let us discuss,how an AO will approach the issue of introduction/increase of share capital in a company. Where the assessee company accepted share with high premium, the AO should examine the genuineness of this transaction first. If the source of fund, identity of the subscribers and the genuiness of the transaction are not proved beyond doubt, obviously it is a case of undisclosed income routed back in the guise of Share Capital. Therefore Sec 68 of I.Tax will apply and no need to apply or examine the applicability of Sec 56(2)(viib) of Income Tax Act. However the calculation of NAV may be utilized to strengthen the non genuineness of the transaction.Lets examine some judicial pronouncements in this issue:

Hon’ble Keral High Court in the case of Sunrise Academy Of Medical Specialities India Pvt Ltd Vs ITO [2018] 96 taxmann.com 43 (Kerala) decided that in a company in which public is not substantially interested, any premium received by said Company on sale of shares, in excess of its face value, would be treated as income from other sources, satisfactory explanation under Section 68 would not save Company fromexcess share premium taxability under Section 56(2)(viib).

a. Hon’ble Mumbai ITAT in the case of Pratik Syntex (P.) Ltd. v. ITO [2018] 94 taxmann.com 12 (Mum. – Trib.), the taxpayer during FY 2011-12 raised a certain sum by issuance of shares of Rs. 10 per share face value at a premium of Rs490 per share, from new shareholders. But on the question of substantiation of share valuation, it could not rely on its financial statements, business model and financial indicators as existed in its audited financial statements to justify the premium. The assessee could not bring on record project report or any other cogent material justifying issue of shares at huge premium which could reflects viability, higher profitability and bright future prospects of the assessee company by implementing project for which funds were raised at huge share premium to justify chargeability of such a huge share premium. It was observed that thoughs. 56(2)(viib) r.w.s. 2(24)(xvi) comes into effect from AY 2013-14 does not mean that for earlier years the assessee is not required to justify the identity, genuineness and creditworthiness of the transaction. The burden is very high for closely held companies. Mere submission of name & address, Balance Sheet & bank statement of the subscribers is not sufficient to discharge the onus.

c. THE CASE OF M/S NRA IRON & STEEL PVT. LTD. (SC) DATED 5TH MARCH 2019 It was decided by Hon’ Supreme Court…..

“13. The lower appellate authorities appear to have ignored the detailed findings of the AO from the field enquiry and investigations carried out by his office. The authorities below have erroneously held that merely because the Respondent Company – Assessee had filed all the primary evidence, the onus on the Assessee stood discharged.

The lower appellate authorities failed to appreciate that the investor companies which had filed income tax returns with a meagre or nil income had to explain how they had invested such huge sums of money in the Assesse Company – Respondent. Clearly the onus to establish the credit worthiness of the investor companies was not discharged. The entire transaction seemed bogus, and lacked credibility.

The Court/Authorities below did not even advert to the field enquiry conducted by the AO which revealed that in several cases the investor companies were found to be non-existent, and the onus to establish the identity of the investor companies, was not discharged by the assessee.

14. The practice of conversion of un-accounted money through the cloak of Share Capital/Premium must be subjected to careful scrutiny. This would be particularly so in the case of private placement of shares, where a higher onus is required to be placed on the Assessee since the information is within the personal knowledge of the Assessee. The Assessee is under a legal obligation to prove the receipt of share capital/premium to the satisfaction of the AO, failure of which, would justify addition of the said amount to the income of the Assessee.

 15. On the facts of the present case, clearly the Assessee Company – Respondent failed to discharge the onus required under Section 68 of the Act, the Assessing Officer was justified in adding back the amounts to the Assessee’s income. ”.

Therefore,it is important to examine the real transactions under the hood of share capital. Financial strength of investors are a real indicators. AO to exmine on oath the investors,

1. What is their source of income and income for last 3 years to justify such huge investment in unquoted shares.

2. Why they are investing in a company which does not justify premium (NAV calculation will come handy in this case)

These confrontations coupled with identity of investors,may expose the sham transaction instead of real investment in share capital. The investors in most of the cases are shell companies. Therefore,AOs are advised to examine this aspect before applying Sec 56(2)(viib) of Income Tax Act 1961.

APPLICATION OF SEC 56(2)(VIIB) OF INCOME TAX ACT 1961

Once the AO is satisfied with genuineness of the transaction, next step is to apply Sec 56(2)(viib) of Income Tax Act 1961.

The assessee must have submitted the Fair Market Value (FMV) of shares based on NAV or DCF method.The AO must satisfy that the valuation certificate is from Merchant Banker and not from an accountant if it is done after 24 May 2018.Otherwise it can be rejected and own valuation can be done.

Now the AO has to examine,whether the FMV calculation is acceptable or not based on the facts and figures on the record.

In case of valuation done on the Net Asset Value (NAV) method,it is straight forward. The AO must make sure that the method prescribed in Rule 11UA of Income-tax Rules 1962 is applied properly,otherwise own valuation can be made.

Most litigated part is,if assessee applies Discounted Cash Flow Method (DCF). The AO must examine the methodology, facts and figures used to calculate the future projections. Most of the times the valuer (Merchant Banker and/or the Accountant) simply relies on the data provided by the Assessee,without going into the genuineness of facts or reliability.

The AO has all the power to question the methods as well as the figures used in calculation under Rule 11 UA of Income Tax Rules 1962.

Now let us examine the judicial decisions in this regard.

CAN THE AO CHANGE THE METHOD OF VALUATION?

1.  The Hon’ble ITAT Delhi in the case of M/s Agro Portfolio (P) Ltd. –vs- Income Tax officer,Ward-1(4), New Delhi [2018] 94 taxmann,com 112 (Delh-Trib) has the occasion to go through a similar issue.Assessee was allotted shares to a company and fair market value of shares was done by aMerchant bankers only on basis of Direct Cash Flow (DC) method, only depending on data supplied by assessee and no evidence was produced for verifiying the correctness of data supplied by assessee. The Hon’ble ITAT, Delhi found the action of the AO justified in rejecting DCF method and adopting Net Asset Value method.

2.  In the case of M/s TUV Rheinland NIFE TUV Rheinland NIFE v. ITO (IT Appeal No. 3160 (Bang,) of 2018, dated 27-2-2019 (Bangalore ITAT) while dealing with this issue, the Bangalore ITAT upheld the order of the tax officer who had rejected the DCF method of valuation adopted by the taxpayer and made addition under Section 56(2)(viib) of the IT Act basis the NAV method. The tax officer, upon examining the valuation report concluded that the valuation report had solely relied on the values provided by the management of the Taxpayer, which were adopted to arrive at the FMV to justify the high premium. The tax officer recomputed the FMV of the shares of the Taxpayer using the NAV method and made relevant additions, which were upheld by the CIT(A).

The ITAT addressed the argument of the Taxpayer that it has the statutory right to select one of the two methods prescribed for the purposes of Section 56(2)(viib), one of them being DCF method. In addressing this argument as well as the contention that the right of a tax officer was limited to verifying the arithmetical accuracy of the method selected by the Taxpayer, the ITAT clarified that the tax officer had not questioned the right of the Taxpayer to choose the method of valuation, but after examining the projections, he had questioned the projections/numbers. Thus, in absence of any justifications for the projections used in determining FMV under DCF method, the ITAT agreed with the decision of the tax officer to deploy NAV method. The ITAT thus upheld the authority of the tax officer to override the choice of valuation method adopted in certain circumstances.

However,in the following case change of method of valuation was not approved.

1.  The Hon’ble ITAT in the case of M/ Rameshwaram Strong Glsss (P) Ltd vs-The Income Tax Officer (ITA 884/JP/2016 dated July 12, 2018) has observed that the tax authorities can scrutinize the valuation report to the extent of finding any arithmetical mistakes. The ITAT also observed that the tax authorities are entitled to scrutinise the valuation report and determine a fresh valuation either by themselves or by calling for a final determination from an independent valuer to confront taxpayers if the tax authorities find that the working of the valuer or the assumptions made are erroneous or contradictory. In such case, the tax authorities may suggest necessary modifications and alterations to the valuation report provided the same are based on sound reason and rationale.

However it, has upheld the right of the company issuing shares to choose the valuation methodology under the provisions of the Income Tax Act, 1961 read with the rules framed there under for the purposes of determining the ‘fair market value’ (FMV) of such shares at premium. It held that the tax authorities cannot require the taxpayer to change the valuation method adopted by it, when the Tax Law grants an option to select either the Net Asset Value (NAV) method or the Discounted Cash Flow (DCF) method.

The Hon’ble ITAT relied on the case of ITO Vs M/s Universal Polysack (India) Pvt. Ltd. [I.T.A. 609/JP/2017 dated January 31, 2018] wherein the Coordinate Bench of ITAT Jaipur held that the exercise of such an option by the taxpayer is not subject to fulfillment of any specified conditions and it is left to the sole discretion of the taxpayer.

2.  In the case of M/s Innoviti Payment Solutions Pvt. Ltd. v. ITO [2019] 102 taxmann.com 59/175  ITD  10  (Bang ) the Hon’ble ITAT held that it would be pertinent for the Taxpayer to substantiate the basis of the projections and estimates, used for the purpose of computing the FMV under the DCF method. However, if the tax officer is not satisfied with the valuation report provided by the Taxpayer, he may make additions basis his own estimates, but he would have to follow the same method which has been chosen by the Taxpayer for the purpose of such valuation.

The Hon’ble ITAT in this case considered the technical guide on share valuation issued by the Institute of Chartered Accountants of India, and laid down few principles in relation to 56(2)(viib) valuations:

Firstly, only the data and facts available on the date of valuation should be considered for scrutinizing valuation reports and reliance should not be placed upon actual result of future to judge the veracity of the projections/estimates. Secondly, the primary onus of proving the correctness of the valuation report would be on the Taxpayer as he/ she possess special knowledge pertaining to the business of the company. Lastly, if the tax officer is not satisfied with the valuation, he should record the reason for the same and only then he should obtain a fresh valuation report.

CAN THE AO CHANGE THE VALUATION?

As we have already observed in above mentioned judgements it is a big Yes.Unless and until the assessee provides the evidence justifying the facts and figures provided to the merchant banker with their justification it would not be possible either to consider the merits of the DCF method adopted by the assessee or to make suitable adjustments to the same for correct determination of the share price.

Let us go through some other judgments also.

1.  In a case where valuation report by a CA on valuation of shares is filed by the assessee as per requirement made by AO, assessee is not precluded from filing another report from registered valuer which may give higher figure of valuation. The AO is required to give opportunity to assessee and thereafter he can reject or adopt any valuation. [refer- ASG Leather (P.) Ltd. v. ITO [2018] 95 taxmann.com 151 (Kolkata – Trib.)

In the case of M/s Sadhvi Securities P. Ltd. ACIT (ITA No.1047/Del/2018) Delhi, ITAT dated 16.07.2019,the valuation was not done properly,hence AO’s action was confirmed.

“12. We do not find any merit in the argument of the ld. counsel for the assessee. A perusal of the Rule 11U(b) as reproduced by CIT(A) at para 5.6 of his order makes it clear that the balance sheet means the balance sheet as drawn up on the balance sheet date which has been audited by the auditor of the company and where the balance sheet on the valuation date has not been drawn up the balance sheet drawn up as on a date immediately preceding the valuation date which has been approved and adopted in the AGM of the shareholders of the company. We find in the instant case,on the date of receipt of the consideration the balance sheet of the assessee company was not drawn up as the same was drawn up only on 31st July, 2014 which is evident from the audited balance sheet filed. Clause (b) and clause (j) of Rule 11UA makes it clear that for computing fair market value of the shares the value of the assets and liabilities as stated in the audited balance sheet immediately prior to the receipt of consideration should be adopted. If, on the date of receipt of the consideration, the balance sheet was not drawn up, then, the balance sheet drawn up as on a date immediately preceding the valuation date should be adopted i.e., the balance sheet of the immediately preceding year should be adopted. We find, in the instant case, on the valuation date i.e., on 31.03.2004, the balance sheet was not drawn up by the auditor as audited financials were drawn up only on 31st July, 2014 and, therefore, we concur with the observation of the ld.CIT(A) that the valuation of assets and liabilities in the balance sheet of the immediately receding year i.e., 31.03.2013 should have been adopted. Since the valuation done by the assessee was not in accordance with the Rule framed for valuation of unquoted shares i.e., the assessee has not taken the value of assets before introduction of share capital received through fresh allotment and since the Assessing Officer has correctly determined the valuation of the unquoted equity shares which has been upheld by the CIT(A), therefore, we do not find any infirmity in the order of the CIT(A). Accordingly, the same is upheld and the grounds raised by the assessee are dismissed.”

3.  In the case of M/s KottaramAgro Foods (P) TS-762-ITAT-2018(Bang) 102 taxmann.com 183 The Hon’ble ITAT affirmed the AO’s NAV based valuation. ITAT ruled that the auditor cannot be an accountant for the purposes of Rule 11UA (2) [dealing with share valuation for the purpose of excess share-premium taxability u/s 56(2)(viib.It noted that though the assessee had filed share valuation report certified by auditor (valuing shares at Rs. 400/- as on March 31, 2014) which was rejected, AO had accepted the earlier valuation report of 2012 by an ‘Accountant’ in terms of Rule 11UA valuing shares as on March 31, 2012 (at Rs. 100/-); ITAT remarks that, “when an auditor cannot be accepted as an accountant for the purposes of Rule 11UA (2)…there is no option available to the AO but to accept the earlier report … valuing the shares at Rs.100/- per share instead of Rs. 400/- per share…”, further highlights the rise in valuation 4 times when the valuation is certified by an auditor, thereby vindicating the restriction contained in Rule 11UA on auditor’s acceptance as accountant.

Therefore,the AOs must ascertain the actual nature of transaction. If it does not attract provisions of Sec 68,then procced to examine the applicability of Sec 56(2)(viib) in the light of above judicial pronouncements. Also keep in mind Section 56(2)(viib) of the Income-tax Act, 1961 is an anti-abuse provision which seeks to tax excessive premium received from Indian residents by closely held companies (i.e. monies received in excess of the Fair market value of the shares) on issue of shares – popularly known as the ‘Angel Tax’. However, to restrict the wide tax net of this provision which also applies to start-ups that thrive on high value angel funding, the Department, for Promotion of Industry and Internal Trade, through a notification dated February 19, 2019, has defined start-ups who should be exempt from Angel Tax, subject to such entities satisfying the prescribed conditions. This exemption regime was formalized by the Central Board for Direct Taxes, through a notification dated March 5, 2019.

CONCLUSION

To conclude, the AO should first examine whether the case in hand is one of genuine transactions.If the answer is in the negative, he shall have to investigate the case to bring the appropriate sum under Section 68 of the Act. If it is a genuine transaction, the matter becomes a technical issue requiring in depth study of the valuation methods.

Source- Taxalogue 3- April to June 2020

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