Shares issued below fair market value- No tax if issued on proportionate basis
Presently section 56(2)(x) of the Income Tax Act, 1961 provides for the taxation of receipt of specified assets for inadequate or without consideration in the hands of any person if the receipt is made without consideration or for inadequate consideration in excess of Rs. 50,000/-. Section 56(2)(x) is applicable in the hands of the purchaser.
There is an interesting case by the Mumbai bench of the Income Tax Appellate Tribunal in the case of Sudhir Menon HUF v. Asst. CIT wherein it was held that nothing is taxable in the hands of the purchaser if shares below the FMV is on a pro rata basis where after allotment or issue of fresh shares, the shareholding percentage remain the same.
FACTS OF THE CASE:
Sudhir Menon HUF was an assessee in the present case which held 15,000 shares in a company, Dorf Ketal Chemicals Private Limited representing 4.98% of its share capital. The Assessee was offered additional 3,13,624 shares of DKCPL at a face value of INR 100 each, on a proportionate basis with other shareholders. The Assessee subscribed to 1,94,000 of the offered shares along with the other shareholders, who subscribed to both shares similarly offered to them and the shares not subscribed to by the Assessee. Consequent to such subscription, the Assessee’s holding in DKCPL reduced from 4.98% to 3.17%.
As the FMV of the shares of DKCPL shares determined2 as on September 3, 2009 was INR 1,538 per share, the Assessing Officer (“AO”) sought to tax the Assessee on the difference between FMV and subscription price of the shares, as ‘Income from other sources’ under Section 56(2)(vii)(c) of the ITA. The Commissioner of Income Tax (Appeals) confirmed the said levy of tax by the AO. Aggrieved by such order, the Assessee approached the Tribunal on second appeal.
Mumbai ITAT held as under:
- Issuance of shares could not be treated as a rights issue as Section 81 of the Companies Act, 1956 does not mandate a private company to undertake a rights issue. The Tribunal noted that the scheme of the Assessee did not provide for a right of renunciation by the existing shareholders and that the company was entitled to appropriate that right and offer it to another person, not being an existing shareholder. Hence, this ruling is applicable to any share issuance by a company, whether as a rights issue or otherwise.
- The Tribunal observed that in a case where additional shares are issued by a company to the shareholders proportionate to their existing holding, no additional property is received by the shareholder and there is no income in the hands of the shareholders. Accordingly, no tax is payable under Section 56(2)(vii). It is the Tribunal’s opinion that a proportionate issue of shares by a company to its existing shareholders is only an apportionment of the value of their existing shareholding over a larger number of shares and no additional property is transferred to them.
However, the Tribunal noted that increase in value of shareholding on account of a disproportionate allotment would be considered receipt of additional property by the shareholders and would attract Section 56(2)(vii). Accordingly, a case where an allotment of shares to a shareholder is disproportionate to his existing holding on account of another shareholder renouncing his right to participate will also be impacted by Section 56(2)(vii).
- The Assessee, in the course of arguments, equated the issuance of shares in question to a bonus issuance to emphasize how applicability of Section 56(2)(vii) to the present issuance would make even bonus issuances taxable under Section 56(2)(vii), which would lead to absurd results. In this regard, the Tribunal concurred with the Assessee and observed that in case of issuance of bonus shares, the company only capitalizes its profits without affecting the wealth of the shareholders as their respective shareholdings in the company remain constant. In effect, a bonus issuance is a split in the shares of the company in the same proportion for all shareholders, and while the value of each share is reduced there is no receipt of additional property by the shareholders. The Tribunal relied upon the Supreme Court rulings in CIT v. Dalmia Investment Co. Ltd and Khoday Distillers Limited v. CIT to support its conclusion. However, the Tribunal also added that where a bonus issue is coupled with the release of assets by the company in favour of the shareholders, such issuance may be characterized as ‘dividend’ and the issuing company may be subject to dividend distribution tax. This is similar to the reasoning adopted by the Tribunal to hold that a proportionate issuance of shares to existing shareholders is not subject to tax under Section 56(2)(vii).
- The Tribunal also analyzed the import of the word ‘receipt’ appearing in Section 56(2)(vii). An argument was raised by the Assessee that Section 56(2)(vii) was attracted only in case of receipt of property on account of a ‘transfer’ from one person or persons to an individual or HUF. As a subscription of shares did not involve a transfer of shares, Section 56(2)(vii) would not be attracted in such case. The Tribunal negated the argument while observing that the receipt of property by the taxpayer in his own right was the edifice for levy of tax under Section 56(2)(vii), thus, implying that the possession of the asset by a taxpayer was the only pre-condition for levy of tax under Section 56(2) (vii) and the manner of possession was inconsequential.