Applicability of Right Shares Issuance on Face Value based on Renunciation by Family Members 

Case Law

Sec.56(2)(vii)(c) of the Income Tax Act, 1961 inapplicable to right-shares issued in proportion to own & relative’s shareholding

Brief Facts:

• In Assessment Year 2013-14, the assessee was issued 200,000 right shares at face value of Rs.10 in M/s. Kintech Synergy Limited.
• Of the total 200,000 right shares, 103,000 equity shares were issued in proportion to existing shares held by assessee, 82,200 equity shares were issued from renunciation by his wife & father and 14,800 equity shares were received from renunciation by unrelated third party.   
• Assessing Officer issued notice under Sec.148 of the Act on the ground that the correct Fair Market Value (FMV) of shares allotted to the assessee at Rs.5,10,00,000/- far exceeded the consideration of Rs.20,00,000/- paid for receipt of shares as per the provisions of Sec.56(2) of the Act.
• The Assessing Officer computed the FMV and the shares at Rs.255 per share and hold that the differential amount of Rs. 4,90,00,000/- has escaped assessment in the hands of the assessee under the provisions of Sec.56(2)(vii)(c) of the Act, Rs.4,90,00,000/- was taxable under the head of income for other sources.
• Assessee, feeling aggrieved, preferred an appeal before the CIT(A) contending that the Assessing Officer
• The CIT(A) partly allowed the appeal of the assessee holding that to the extent that the assessee was allotted right shares proportionate to not existing holding, the provisions of Sec.56(2)(vii)(c) were not applicable and the Fair Market Value for the remaining shares was held to be Rs.205.55 per share. Thus, out of 200,000 shares, proportionate holding to the assessee’s existing holding (103,000 shares) are not covered by provisions of Sec. 56(2) but in respect of additional shares issued:
  • On renunciation of shares held by wife & father of assessee: 82,200 shares
  • On renunciation of shares held by third party shareholders: 14,800 shares

• Both, the assessee and the revenue, therefore, filed appeals challenging the order of the CIT(A) before the Tribunal.

Tribunal View:

• The Tribunal dismissed the appeal filed by the revenue on both counts i.e. firstly, Sec.56(2)(vii)(c) not being applicable to the right shares proportionate to not existing holdings and secondly Fair Market Value of shares were Rs.205.55 per share.
• The Tribunal partly allowed the appeal of the assessee holding that the issue of right shares proportionate to the holding of wife and father was not taxable under Sec.56(2)(vii)(c). The Tribunal, further held that the provisions of Sec.56(2)(vii)(c) would be applicable in respect of 14,800 shares which were allotted to the assessee as a result of third party declining to apply for the same.
• In the facts of the case, the shares had come into existence only when the allotment is made by the company as right shares cannot be said to be “received from any person”. The shares which have been allotted to the assessee were not “received from any person” which is the fundamental requirement for invoking sec.56(2)(vii)(c). In other words, the property must pre-exist for the application of Sec.56(2) (vii)(c), which is clear from the intention of the legislature.
• Hon’ble Tribunal relied upon the decisions in the case of Sudhir Menon (HUF) vs. A.C.I.T, Mumbai., dated 12.03.2014 of the ITAT Mumbai ‘A’ Bench, and on a decision of the Hon’ble Supreme Court in the case of Ms. Dhun Dadabhoy Kapadia vs. CIT reported in 63 ITR 651 (SC). Further, in the case of H. Holck Larsen Vs. Commissioner of Income-tax, reported in 85 ITR 285 (BOM.), to hold that as long as there is no disproportionate allotment of shares, there was no scope of any property being received by them on the said allotment of shares, as there was only an apportionment of the value of their existing shareholding over a large number of shares and hence no addition under Sec.56(2)(vii)(c) would arise.
• In case of wife & father, tribunal held that had the wife and father of the assessee directly transferred their shares in favour of the assessee, provisions of Sec.56(2)(vii)(c) of the Act could not have been invoked since both of them are falling in the definition of “relatives” which are excluded from within the purview of operation of Sec.56(2)(vii)(c) of the Act.
• In case of renunciation from other shareholders, The Tribunal held against the assessee because renunciation of rights in favour of the assessee by third party who are not related does lead to disproportionate allocation of shares in favour of the assessee.
• For valuation of shares, the Tribunal, therefore, held that since the shares were allotted before balance-sheet for A.Y 2013-14, the CIT(A) did not err in computing the FMV per share considering the previous balance sheet approved in AGM for valuation of FMV of the shares.

Hon’ble High Court View:

• Hon’ble High Court ordered that the Tribunal, therefore, has not committed any error in answering all the four issues which are raised by it holding that sec.56(2)(vii)(c) of the Act cannot be invoked in respect of allocation of 1,03,000 right shares allotted to the assessee proportionate to his shareholding in the company as it cannot be said that the assessee has received as there is transfer of the shares which pre-existed prior to the issuance of shares by the Company as there is vital difference between “creation” and “transfer of shares”.

• The provisions of Sec.56(2) would not be applicable to the issue of new shares as issue of new shares by company as a right shares is creation of property and merely receiving such shares cannot be considered as a transfer under Sec.56(2)(vii)(c) and accordingly, such provision would not be applicable on the issuance of shared by the Company in the hands of the allottee.

• With regard to issue of 82,200 shares, the name of wife and father of the assessee would also not be hit by provision of Sec.56(2)(viii)(c) as both of them would be covered by definition of relative covered in the exemption of relative, and therefore, the provision of section 56. would not be applicable at all.

• CIT(A) has rightly computed the FMV on the basis of the balance sheet which was available on record for the previous year and which was approved in AGM.

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