Last Updated on August 27, 2024 by Kanakkupillai
The topic given here shall be discussed with the help of relevant case law, which was the Rajeev Ratanlal Tulshyan vs. ITO (ITAT Mumbai).
Facts and Conclusion of the Case Law
The assessee here was a director and also the major shareholder of the company name, M/s. Kennington Fabrics Private Limited (hereafter referred to as KFPL).
During the year in question, which was FY 2013-14 or AY 2014-15, KFPL offered a rights issue, and as a part of the same, the assessee here was allotted 3.95 Crores shares of KFPL at a face value of INR 1 per each share allotted in the right issue. But the Assessing Officer or AO was of the opinion that the consideration of INR 1 per share at which the shares were issued to the assessee was lower than the Fair Market Value (FMV) of the shares of KFPL as per the computation made in accordance with the provisions of Sec.56(2)(vii)(c)(ii) of the Income Tax Act read with rule namely the 11U & 11UA provided duly under the Income Tax Rules. So, the difference between the FMV and consideration that was paid on shares issued through the right share should be taxed in the hands of the assessee as per section 56(2)(vii).
The provisions of Section 56(2)(vii) were anti-abuse provisions. This was inserted after the abolition of the Gift Tax Act. It is evident from CBDT Circular No. 05/2010, which holds the date of 03.06.2010, that Section 56 is being presented as an anti-abuse measure. This has also been fortified in CBDT Circular No. 01/2011 dated 06.04.2011, which also provided that these provisions are anti-abuse provisions that were applicable only if an individual or a Hindu Undivided Family (HUF) is the recipient. Therefore, a transfer of shares of a company to a firm or a company, instead of an individual or a HUF, without consideration or at a price that is lower than the FMV would not attract the anti-abuse provision.
Taking into consideration the particulars or details of present case law, AO noted and recorded that proportion of shareholding of the taxable person in KFPL has increased from a ratio of 90.37% as of 31.03.2013 to a ratio of 96.88% as of 31.03.2014 and was of view that there was a disproportionate allotment or portioning of shares and therefore, the stated provisions would apply in the case of this particular assessee.
The assessee here also relied on the decision made in the Mumbai Tribunal in Sudhir Menon HUF, before the Honourable Tribunal. It was held that proportionate allotment of shares would not be taxable under section 56(2)(vii)(c)(ii). But in case of disproportionate allotment of shares, these provisions shall be attracted.
The Honourable Tribunal considered the submissions of the Assessee during appellate proceedings pertaining to CBDT Circular No. 5 of 2010, which holds the date as 03/06/2010 and stipulated that the newly provided provisions of Sec. 56(2)(vii) were anti-abuse measures as stipulated before, along with the other similar circular, CBDT Circular No.1 of 2011. The provisions were intended to extend the tax net to such transactions which were made in kind. The intent was not to tax the transactions that were entered into during the normal course of business and trade and the profits that are taxable under a specific head of income.
Another argument that was made here was that section 56(2)(vii) shall be applicable to a recipient of property or money, and the property inferred here includes shares and securities, which shall be accounted for as capital assets of the assessee. However, it should be noted that these shares came into existence out of allotment from the previously unallotted or unappropriated shares of the company. And it was through such allotment that these shares came into existence. As per the decision made by the Honourable Supreme Court in Khoday Distilleries Ltd. (CA No.6654 of 2008), allotment of shares can only be accounted as the creation of shares and not a transfer of shares. Unlike allotment as stipulated above, transfer of shares is a choice in action, and this means that there is some other person entitled to the rights issue of shares, in contradistinction to a subscriber, and it also includes the purchase of shares from an existing shareholder. However, allotment is not a transfer and does not attract any provisions of the Gift Tax Act. Hence, the non-existence of shares during the time of allotment makes the application of section 56(2)(vii) impossible or not applicable.
The Honourable Tribunal, while allowing the Assesse’s Appeal, also relied on Sudhir Menon HUF Vs. ACIT observed that the coordinate bench held that as long as there was no disproportionate allotment, based on their existing holdings, they had no scope for any property being obtained by them on the allotment of shares as specified. So, in the case of the given scenario, the provisions of Sec.56(2)(vii)(c) would not be attracted. A higher than harmonious or disproportionate allotment, though, would, and on the same basis, draw the application of this provision. So, the same would be applicable only to the extent of the disproportionate allotment and, further, by suitably factoring in the decline in the value of the existing holding.
The program was headed by Vice President Mahavir Singh and Accountant Member Manoj Kumar Aggarwal, who were trusted mainly regarding DCIT Vs. Dr. Ranjan Pai detected that the aim of bringing in or introducing the provisions was anti-abusive measures still remain intact. There is no reason to leave or deviate from the understanding that the provisions were a counter-evasion mechanism to prevent the laundering of any unaccounted income and therefore, the same does not apply to genuine issues of shares to existing shareholders through a right issue.
Hence, we can conclude that the transactions here were considered as ordinary transactions, where the shares were allotted as the right issue in the proportion of the shares which were already held by the shareholder. This thereby accounts for no abuse or tax evasion and thereby puts the assessee out of any additional tax liability which might arise out of the contention made by the AO.
