– Qasim Saif and Mahesh Jethani
finserv@vinodkothari.com
Section 56(2) (viia)
- When shares of closely held company received without consideration or for inadequate consideration
- Where shortfall in consideration as compared to Fair Market Value (FMV) exceeded Rs. 50,000
- Recipient is:
(a) Firm
(b) closely held company
- Then, FMV of such shares exceeding Rs. 50,000/- after reducing the value of consideration paid, if any, was considered as – Income from other Sources.
Section 56(2) (x)
Section 56(2)(vii)/(viia) is inoperative with effect from 1-4-2017
Clause (x) is inserted in section 56(2) to provide that the specified receipts [same as provided in Sec. 56(2)(vii)] will be taxable as income in the hands of any person, under the head ‘Income from Other Sources’
Sub-Clause (c) of Clause (x) of Section 56-Taxation of any property other than Money and Immovable Property: –
- If received without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property shall be considered Income from Other Source
- If there is inadequate consideration whereby the difference between FMV and consideration exceeds Rs.50,000/- then difference in FMV and consideration will be considered as IFOS
Property means the following capital asset of the assessee –
(i) immovable property being land or building or both;
(ii) share and securities;
(iii) jewellery;
(iv) archaeological collections;
(v) drawings;
(vi) paintings;
(vii) sculptures; or
(viii) any work of art.
(ix) Bullion
Reason for amendments
The Memorandum to the section explains the following-
“The existing definition of property for the purpose of this section includes immovable property, jewellery, shares, paintings, etc. These anti-abuse provisions are currently applicable only in case of individual or HUF and firm or company in certain cases. Therefore, receipt of sum of money or property without consideration or for inadequate consideration does not attract these anti-abuse provisions in cases of other assessee.”
Thus, it appears that through insertion of new provision, the scope of the existing anti-abuse provision is widened to make it applicable to all assessee and also clubbing section 56(2)(vii) & section 56(2) (viia).
Important Rulings on Section 56(2) (viia) and 56(2) (x)
Taxability of the credit to the general reserve by the amalgamated company
Date: 22nd February 2019.
Background:
Section 56(2) (viia) is an anti-abuse provision which applies only to cases of bogus capital building and money laundering. It does not apply to an amalgamation where shares are allotted at alleged undervaluation.
Increase in general reserves due to recording of assets of amalgamating company at FMV not give rise to any real income to the assessee. It is capital in nature
Judgement and conclusion:
This is an important judgement by Tribunal which deals with the taxability of the credit to the general reserve by the amalgamated company of the fair valuation of the assets received under the scheme of amalgamation. The Tribunal held that the transaction does not give rise to real income to the assessee and it thus cannot be treated as a business profit.
Provisions of Section 56 (2) (viia) will not be applicable if fair value of the shares received was not higher than the sacrifice suffered by taxpayer under the composition reorganisation scheme, as there is no incremental benefit to the shareholder.
Reserve directly credited to general reserve and not in P&L cannot be subjected to MAT.
Raising of Tax related Objection by RD when Income Tax Authority did not raise the same.
Date: 19th March 2015
Background:
In the instant case the question of law is that whether the RD could raise tax-related objections to the scheme of amalgamation though the ITA raised no objections? Whether the scheme was liable to be rejected based on the RD’s aforesaid objections?
One of the issue that was pointed out that the scheme was devised to evade capital gain tax by virtue of using the device of beneficial ownership and scheme, transferee is acquiring shares without consideration which will attract section 56 (2) (viia)
Judgement and conclusion:
Since the court was required to ensure that the scheme did not contravene any Act, the RD was not only entitled to, but was duty-bound, to bring to the HC’s notice any provision in the scheme that contravened any law. This included the Income tax law and aimed to ensure that the company did not use the HC sanction as a shield to protect itself from consequences of contravention of the law
That the ITA did not object did not prevent the RD from raising objections or making such observations with regard to the scheme as he/ she deemed fit, including those pertaining to tax laws
The HC has held that the RD is entitled to raise objections pertaining to income tax in a merger scheme, even though no objections were raised by the tax authorities.
Application of Section 56(2)(viia)/56 (2) (x) in case of Buy Back
Date:29th June 2018
Background:
Section is a counter evasion mechanism to prevent laundering of unaccounted income under the garb of gifts. The primary condition for invoking the section is that the asset gifted should become a “capital asset” and property in the hands of recipient. If the assessee-company has purchased shares under a buyback scheme and the said shares are extinguished by writing down the share capital, the shares do not become capital asset of the assessee-company and hence s. 56(2) (viia) cannot be invoked in the hands of the assessee company
Judgement and conclusion:
A combined reading of the provisions of sec. 56(2)(viia) and the memorandum explaining the provisions show that the provisions of sec. 56(2)(viia) would be attracted when “a firm or company (not being a company in which public are substantially interested) “receives a property”, being shares in a company (not being a company in which public are substantially interested)”.
Therefore, it follows the shares should become “property” of recipient company and in that case, it should be shares of any other company and could not be its own shares. Because own shares cannot be become property of the recipient company.
Accordingly, Tribunal was of the view was that the provisions of sec. 56(2) (viia) should be applicable only in cases where the receipt of shares become property in the hands of recipient and the shares shall become property of the recipient only if it is “shares of any other company”. In the instant case, the assessee herein has purchased its own shares under buyback scheme and the same has been extinguished by reducing the capital and hence the tests of “becoming property” and also “shares of any other company” fail in this case.
The tax authorities are not justified in invoking the provisions of sec. 56(2) (viia) for buyback of own shares.
Valuation of Share to be done as per Rule 11UA
Date: 7th March 2018
Background:
Section 56(2)(viia) read with Rule 11UA, The “Fair Market Value” of shares acquired has to be determined by using the values of the underlying assets and not their market values
In the present case, the assessee has acquired shares of TEPL at Rs.5 per shares. The assessee claimed to have valued the shares of TEPL as per the provisions of Rule 11UA of the Rules. AO was of the view that the assets are to be valued at the fair market value which will increase the value of shares to 45.72 and difference Rs. 40.72 being subjected to tax.
Judgement and conclusion:
“Fair Market Value” of a property, other than an immovable property, means the value determined in accordance with the method as may be prescribed”
On the plain reading of Rule 11UA, it is revealed that while valuing the shares the book value of the assets and liabilities declared by the TEPL should be taken into consideration. There is no whisper under the provision of 11UA of the Rules to refer the Fair Market Value of the land as taken by the Assessing Officer as applicable to the year under consideration. Therefore, ITAT was of the view that the share price calculated by the assessee of TEPL for Rs. 5 per shares has been determined in accordance with the provision of Rule 11UA.
Applicability of section in case of “Gift” by one company to another.
Date: 15th May 2018
Background:
Huge volume of shares in a company were transferred by assessee to another company without any consideration and without any proper documentation being executed as per law, giving it name of “Gift”.
Question raised: Will the said transaction be covered by section 56(2)(viia) or is exempt from tax u/s 47(iii) of the Income Tax Act, 1961 (the Act)
Judgement and conclusion:
After considering all the facts and circumstances of the case, it is held that the AO has correctly observed that gift by a corporation to another corporation is a strange transaction as there cannot be a gift between artificial entities/persons. The submissions filed by the Appellant are considered and not found to be tenable.
The assessee has to establish to the hilt, the factum, genuineness and validity of the transaction, the right to enter into such transaction especially when, revenue challenges its genuineness. There is no agreement/document that has been executed between group companies forming part of family realignment. To postulate that a company can give away its assets free to another even orally, can only be aiding dubious attempts at avoidance of tax payable under the Act unless it is supported by documentary evidence
It has been vehemently contested by authorities. CIT (DR) contented that transaction has been effectuated for avoiding payment of tax and to get out of the ambit of section 56 (2) (viia) of the Act. Hence benefit of exemption under section 47 (iii) can not be granted.
Application of Section in case of Bonus Issue
Commissioner of Income-Tax vs Dalmia Investment Co. Ltd (Supreme Court)
Date:13th March 1964
Background
There has been a constant flip flop by the CBDT on the issue that whether the provisions of the given section would apply on fresh issue of shares. As the ambiguity prevails the highly celebrated case can be referred for determining applicability of section on Bonus Issue.
Judgement and Conclusion
The apex court in the given case while adjudicating the issue of taxability on transfer of shares held that the Bonus shares were acquired “Without Payment of price and not without consideration” hence it can be implied that Section 56(2) (viia) would not apply in case of bonus issue.
Whether it is valid in law to assess the difference between the value of the shares allotted to the taxpayer and the consideration paid by it, as the taxpayer’s income?
Date: 12th March 2014
Background:
Section 56(2)(vii) (c) (ii) provides that where an individual or a HUF receives any property for a consideration which is less than the FMV of the property, the difference shall be assessed as income of the recipient. The section does not apply to the issue of bonus shares because there is a mere capitalization of profit by the issuing-company and there is neither any increase nor decrease in the wealth of the shareholder as his percentage holding remains constant. Similar view can be taken while considering rights issue as well.
Judgement and conclusion:
Since Right Shares are allotted on the basis of original holding, it cannot be said that same have been allotted at a price less than the fair market value without consideration. Therefore, provisions of Section 56(2)(x) of the Act are not applicable. Moreover, in view of specific provisions of Section 55(2)(aa)(iii) cost of acquisition of these shares will be taken to be the actual price paid by the shareholder and same is not to be adjusted by the amount of deemed income in terms of section 49(4) of the Act, applicability of provisions of section 56(2)(x) is not intended. However it shall be noted that in case the right is assigned to a person the given section would apply.
Valuation of share can be done only on basis of FMV and Not Market Value:
Date: 2nd May 2018
Background
A.O. observed that two persons transferred their shares to the assessee at Rs.75.49 per share whereas, on the same day all the other shareholders transferred their shareholdings to the assessee at Re.1 per share. He observed that when the market rate is Rs.75.49/share, the assessee has purchased the shares at less than the market price i.e., Re.1 per share and therefore, the transactions attract provisions of section 56(2) (viia) of the I.T. Act.
The assessee however argued that under section 56(2)(viia) FMV as calculated under Rule 11U is to be considered and not market price. And FMV of the shares were negative and hence the section has no applicability in the given case.
Judgement and Conclusion
The Tribunal on due consideration ruled that the action of AO was outside the ambit of law and only FMV under Rule 11U can be considered and not Market price. Hence dismissing appeal by the AO.
Application of Section on acquisition of shares before 1st July 2010.
Date: 30th August 2016
Background
In the given case the assessee had acquired shares prior to notification of section 56(2) (viia), that is before 1st July 2010 however the said case came into consideration after the notification of said section the Assessing officer, reassessed the income of assessee giving impact of section 56 (2)(viia). Which was challenged by the assessee
Judgement and Conclusion
The ITAT upheld the argument forwarded by the assessee and ruled that in case transaction had been undertaken before the notification that is to say before 1st July 2020 that income would not be readjusted based on provisions of section 56(2)(viia).
Section 56 (2) (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:
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
Important Ruling on Section 56(2) (viib)
Discretion of Assessee to choose method of Valuation
Date: June 27, 2019
Background:
The assessee has the option under Rule 11UA (2) to determine the FMV by either the ‘DCF Method’ or the ‘NAV Method’. The AO has no jurisdiction to tinker with the valuation and to substitute his own value or to reject the valuation. He also cannot question the commercial wisdom of the assessee and its investors.
Judgement and Conclusion:
It is a well settled position of law with regard to the valuation, that valuation is not an exact science and can never be done with arithmetic precision.
Also, an important angle to view such cases, is that, here the shares have not been subscribed by any sister concern or closely related person, but by an outside investors like, Anand Mahindra, Rakesh Jhunjhunwala, and Radhakishan Damani who are one of the top investors and businessman of the country and if they have seen certain potential and accepted this valuation, then how AO or Ld. CIT(A) can question their wisdom.
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