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CRITICAL ISSUES

CRITICAL ISSUES IN TAXATION. CRITICAL ISSUES. DIRECT TAXATION. SECTION 56(2)(vii). Individual/HUF. Exclusions: From any relative (In case of HUF: any member thereof) On the occasion of marriage of the individual . Under a will or by way of inheritance

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CRITICAL ISSUES

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  1. CRITICAL ISSUES IN TAXATION CRITICAL ISSUES DIRECT TAXATION

  2. SECTION 56(2)(vii) Individual/HUF • Exclusions: • From any relative (In case of HUF: any member thereof) • On the occasion of marriage of the individual. • Under a will or by way of inheritance • In contemplation of death of the payer • From any local authority as defined under section 10(20) • From any fund or formation or university or other educational institution or hospital or other medical institution or any other trust or institution referred in Sec 10(23 c) • From any trust or institution u/s 12AA receives Sum of Money/Movable property/Immovable property Aggregate Value of which exceeds Rs. 50,000 From any person or person(s)

  3. Critical Issues • Only Individual and HUF covered • Company and Firm covered u/s sec. 56(2)(viia). • Private trust/ AOP/ BOI/ co-operative society not covered. • Gift on occasion of marriage of individual can be accepted only by the individual who is getting married. • Gift received by parents/ guardians fully taxable [ Rajender mohanlal v. DCIT, ITAT- CHD affirmed by Punjab & Haryana HC] • Relative: lineal ascendant or descendant (include maternal side as well as paternal side – Sec. 3F of Hindu succession act)

  4. ISSUES-Sec 56(2)(vii) 1. 2. If trust is “Determinate” or “Specific Trust”: Than the money or property actually belong to the beneficiary in the ratio or specified in the trust deed If trust is “discretionary trust”: trustee can not give away properties of the trust to beneficiaries and can only use trust assets for the benefits of beneficiaries. Specific Trust has many advantages Whether Transfer of money or property from a private trust to the beneficiary would be taxable in the hands of beneficiaries?? Whether any amount given free of interest without any consideration will come within the purview of Section 56(2)(vii) ? The consideration for the interest free loan is the legal commitment and obligation to return the money and no tax liability emerge.

  5. SECTION 56(2)(vii)(a) Firm/Company (being closely held company) • Exclusions: • Transaction not regarded as transfer under Section 47: • In Scheme of Amalgamation (transfer by the amalgamating company) • In a Demerger • Issue of shares by the resulting company in a scheme of demerger to the shares of demerged company • In a scheme of amalgamation (transfer by the shareholders) • Shares of predecessor co-operative bank in consideration of successor co-operative bank. Shares of closely held company receives from Any person/persons With/without consideration FMV exceeds 50,000

  6. ISSUES-Sec 56(2)(vii)(a) 1. Whether issue of fresh shares (Bonus shares/ Right shares/ shares allotted in a preferential issue) at a price less than the FMV would attract section 56(2)(vii)(a)?? Bonus Shares: The consideration is actually reduction in value of original shares Right Shares: The shares are issued proportionately to only existing shareholders. The price at which it is issued could be any price and the same will be FMV as per valuation principles. Preferential Issue: The shares have to be issued at FMV. The Companies Act also require the shares to be issued based on valuation. In case shares are issued at a price less than Fair Market Value (FMV) , the section may get attracted.

  7. ISSUES-Sec 56(2)(vii)(a) Whether issue of debenture (whether convertible/partly convertible/non-convertible) will attract Section 56(2)(vii)(a)?? 3. 2. • Warrants are not shares • Issuance of warrant will not attract Section 56(2)(vii)(a) • When Warrants are subscribed/exercised shares have to be issued at FMV. Whether issue of warrants (which entitles the investor to subscribe for equity shares) will attract Section 56(2)(vii)(a)?? • Issuance of bonds are not covered by section 56 (2)(vii)(a) • Buying and selling of bonds/NCD/OCD/PCD/FCD will not be covered by the section • A company buying shares at a price less than FMV will be taxed. • A company selling shares at beyond FMV will not be taxable till cost plus index

  8. ISSUES-Sec 56(2)(viiA) 5. 4. Will section 56(2)(vii)(a) apply if share are settled on a trust if the beneficiary of the trust is a firm or a company?? Whether receipt of equity share on conversion of preference shares/debentures attracts 56(2)(vii)(a)?? Receipt of shares at the time of conversion maynot be treated as receipt of shares for lower consideration as the conversion do not involve “ Received from any person or persons at the date of conversion. This section shall not apply on trust even if the beneficiary of the trust is a firm or a company or individual or any other person This section shall be applicable only if the receiver of the shares is a company or a firm

  9. ISSUES-Sec 56(2)(vii)(a) 6. 7. Will Section 56(2)(vii)(a) apply if shares are distributed by a trust to its beneficiaries who are firms or companies?? Will Section 56(2)(vii)(a) apply if shares are received by a trust by purchase or subscription Where the shares are distributed by a trust to its beneficiaries who are companies/firms Section 56(2)(vii)(a) will be applicable because Section 56(2)(vii)(a) is talking of receipt of shares and not purchase or transferor or donor. Transferor or donor can be any person or persons Section 56(2)(vii)(a) will have no application

  10. ISSUES-Sec 56(2)(vii)(a) 8. Whether receipt of shares of each individual transaction should be considered separately or aggregate share of all companies received during theyear ? EXAMPLE:

  11. ISSUES-Sec 56(2)(vii)(a) 9. For determining the taxable amount should one aggregate transaction of inadequate / Nil consideration is considered or aggregate of all transaction including transaction with adequate consideration?? Adequate Consideration – separately (Inadequate consideration– FMV) > 50000 -- separately Without Consideration , FMV > 50000 – separately AGGREGATE --- INCORRECT

  12. SECTION 56(2)(vii)(b) Closely held Company • Exclusions: • Consideration for issue of shares is received: • By a venture capital undertaking from venture capital company or venture capital fund. • By a company from a class or classes of persons as be notified by the central government in this behalf. Any consideration for issue of shares on premium receives From resident Aggregate consideration received exceeds FMV of the shares

  13. Valuation of shares : Rule 11 UA • For Section 56(2)(vii) and Section 56(2)(viia) • Quoted Equity Shares • Transaction through recognised stock exchange • Transaction value as recorded in such stock exchange • Transaction through un-recognised stock exchange • FMV will be • The lowest price of such shares and securities on any recognised stock exchange on the valuation date. • If shares did not trade on the valuation date then the lowest of such shares on the recognized stock exchange on a date immediately preceding the valuation date when such shares were traded on such stock exchange. • Unquoted Equity Shares • FMV = (Assets – Liabilities) x Paid up value of such equity share • Total Amount of paid up equity share capital

  14. Valuation of shares : Rule 11 UA For Section 56(2)(viib) Option 1 – Same as Section 56(2)(vii) / 56(2)(viia) Option 2- The Fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the discounted cash flow method. Accountant: Any fellow CA who is not auditor of the company under section 44AB or statutory auditor whether he is in practice or not. Treatment of : Special / Capital/ Revaluation reserves – Liability excludes Reserves & surplus by whatever name called. DTL/ DTA – Not included in asset / liability Contingent Liability - Exclude other than arrears cumulative preference share dividend

  15. ISSUES-Sec 56(2)(ix) • This clause is inserted by Finance Act,2014 w.e.f. 01-04-2015 (Assessment Year 2015-2016) • (ix) Any sum of money received as an advance or otherwise in the course of negotiation for transfer of capital asset if, • Such sum is forfeited AND • The negotiations do not result in transfer of such capital asset. • Consequent Amendment has been made in Sec 51 • Such sum shall not be deducted from the cost for which the asset was acquired or the WDV or the FMV, as the case may, in computing the cost of acquisition.

  16. ISSUES-Sec 56(2)(vix) New Provision: Amt. Forfeited – 50,00,000 This amt. shall be taxable under income from other sources. Amt. forfeited - 50,00,000 Original COA – 10,00,000 Old Provision: Amount forfeited is deducted from COA , it becomes negative and no treatment for 40,00,000 has been done. • In the hands of Buyer: • The amt. forfeited would not be allowed as capital loss. • If the seller fails to honor the deal and refund back the advance received as well as compensation, such amt. would be treated as capital gain. • The Amt. forfeited by the seller shall not be allowed as deduction as revenue expense because it was for capital asset.

  17. Section 14(A) : Expenditure incurred in relation to exempt income not includible in total income No deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of total income under this act. • Rule 8D ( inserted vide notification S.O. 547 (E) • Sub Rule (1) Where AO is not satisfied with • Correctness of the claim of expenditure • Claim made by the assessee that no expense has been incurred. • He shall determine such expenditure in accordance with the provision of Sub Rule (2). Expenditure under Sub Rule (2) of 8D Expenditure directly related to exempt income For interest paid not directly attributable to any income (A x B / C) A = Amt. of interest B = Avg. value of investment C = Avg.of total Assets 0.5% of Average value of investment

  18. Section 14(A)-Constitutional validity of Provisions

  19. Section 14(A)-Constitutional validity of Provisions

  20. Section 2(22)(e)- Deemed Dividend • Provision: • Dividend includes: • Any payment by a company not being a company in which the public are substantially interested of any sum by the way of advance or loan to To the extent to which the company possesses Accumulated Profits

  21. Section 2(22)(e)- Deemed Dividend Dividend under Section 2(22)(e) is taxable in the hands of: Such dividends shall be taxable in the hands of the shareholder normal tax rate u/s 56 of I.T. Act, 1961. at Shall not required to pay tax on such deemed dividend u/s 115 O of I.T. Act. Note: Where as dividend u/s 2(22) (a), (b), (c), or (d) is exempt in the hands of shareholder u/s 10 (34) , the company shall pay CDT on it u/s 115 O of the I. T. Act. Shareholder Company

  22. Section 2(22)(e)- Deemed Dividend “Substantial Interest” in a concern - as per Explanation 3 of Sec2(22)(e) • ... if he is, at any time during the previous year, beneficially entitled to not less than 20% of the income of such concern. • shares held by a shareholder in his own name and held as guardian to be considered. • [Case law: CIT vs. Sokkalal (T.P.S.H) 236 ITR 981 (Mad.)(1999)] • To determined the substantial interest of a person in a concern-share held by him/her in two different capacities, e.g. as individual and as HUF cannot be clubbed. • [Case law: CIT vs. Kunal Organics (P.0 Ltd. 164 taxman 169 [2007] (Ahd.)] • Meaning of “CONCERN” – As per Explanation 3 of sec 2(22)(e) • AOP • BOI • Company • HUF • Sole Proprietor • Firm

  23. Section 2(22)(e)- Deemed Dividend Following conditions are required to be fulfilled for the availability of sec 2(22)(e) • Company- should be one in which the public are not substantially interested i.e. should be a closely held company. • Person- should be a shareholder having not less than 10% of voting power. • Payment- should be by way of advance or loan and made out of accumulated profits of the company. • In case loan or advance is to a concern, shareholder should have a substantial interest in that concern at any time .during the year

  24. Section 2(22)(e)- Deemed Dividend • Where a loan is advanced to a shareholder, he/it Must be the registered as well as a beneficial owner of shares. However, where the shareholder is a beneficial holder but not the registered holder of shares, even then section 2(22) (e) would not attract to him. • [Case law: Rameshwarlal Sanwarmal vs. CIT 122 ITR 1 [1980] (SC) • Loan to HUF, where members are shareholders . • The Tribunal held that the loan advanced by a private company to HUF of which the members were directors in the company cannot be deemed as ‘Dividend ’in the hands of HUF as HUF was not a registered shareholder. • ITO v. S.S. Shetty 14 TTJ 71 (Bom) also see Harish ChandGolechav. CIT [1981] 132 ITR 0030 (Raj).

  25. Section 2(22)(e)- Deemed Dividend Deemed Dividend u/s 2(22)(e) is taxable in the hands of Ultimate Recipient of the loan amount... • Deemed dividend can be assessed only in hands of a person who is a shareholder of lender company and not in hands of a person other than a shareholder. • Deeming fiction of s. 2(22)(e) can be applied only in the hands of the shareholder and not the non-shareholder [Section 2(22) of the Income-tax Act, 1961 • [Sadana Brothers Sales (P.) Ltd. v. Asstt. CIT [2011] 10 taxmann.com 122 (Indore - ITAT) • In the hands of Shareholders – Taxable • In the hands of Concern – Not taxable Company Concern Loan 10% or more voting power Shareholder Substantial interest

  26. Section 2(22)(e)- Deemed Dividend • If loan amount < Accumulated profits • then entire amount of loan is considered as deemed dividend. • If loan amount> Accumulated Profit, • the amount of loan to the extent of entire Accumulated profits(and not to the extent of his share in Accumulated profits) will be treated as dividend. • [Case law: CIT v. Arati Debi [1978] 111 ITR 277 (Cal.)] • Duration of loan is not material • Advance towards personal expenses shall be treated as deemed dividend • Loan made by company to the employees i.e. Managing Director assessable in the hands of shareholder • A loan in kind attract the provisions of deemed dividend-Any payment by a company of any sum representing a part of the assets by way of advance made by the company to the shareholder by the transfer of goods would come in to the provisions of sec. 2(22)(e). • [Case law: M.D. Jindal vs. CIT 164 ITR 028 (Cal.)(1987)]

  27. Section 2(22)(e)- Deemed Dividend • When a Shareholder doing business with company & always having debit balanextent of Accumulated profits to cover the debit balance, would be regarded as deemece, the amount would be regarded as loan by the company and to the d dividend u/s 2(22)(e). • Repayment of an earlier loan could not be adjusted against advancement of fresh loan, which had been deemed to be dividend under section 2(22)(e) of the Income-tax Act. • Provisions of Deemed Dividend shall not be applicable to loan received prior bearing substantial and beneficial interest in a concern. • Ravindra D. Amin v. Commissioner of Income tax[1994] 208 ITR 0815 [Gujarat High Court] • Amount credited to the account by way of interest of loan having opening balance can not be taxable as deemed dividend. • Sec 2(22)(e) covers only the amount received during the PY by way of loan/advances.

  28. Section 2(22)(e)- Deemed Dividend • Repayment of loan or any other adjustment- e.g. Remuneration of shareholders credited to the loan a/c cannot be set off against loan . • Receipt in the nature of share application money cannot be construed as loan or advance and therefore, it falls beyond the Ken of S. 2(22)(e). • [Case Law : Ardee Finvest (P) Ltd vs. DCIT – ITAT - 70 TTJ (Del) 378] • TDS shall be deducted by the company on such payments. • Amount given as advance for entering in to dealings through shareholder. Could not be treated as deemed dividend under sec 2(22)(e) • CIT V. Sunil Sethi 26 SOT 95 (ITAT-Del.) (2010)] • Mere book entries do ot constitute payment by the company • CIT vs. Smt. Savithri Sam (1998) 144 CTR (Mad) 17 : (1999) 236 ITR 1003 (Mad.) • Deemed dividend assesses, if any, in the hands of the shareholders in the past AY should be deducted from the surplus while determining the accumulated profit in the hands of the company

  29. Section 2(22)(e)- Deemed Dividend Exceptions to the Section 2(22)(e) • Business Transactions are out of the scope of prov. Of sec. 2(22)(e) • But dividend does not include: • any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company. • Onus is on the assessee to prove the facts • Walchand & Co. Ltd. V. CIT 100 ITR 598 (1975) (Bom.)] • Trade advances given to the company will not attract 2(22)(e) • Inter Corporate Deposits are different from loans or advances & would not come within preview of deemed dividend u/s 2(22). • [Case law: Bombay Oil Industries Ltd. V. Dy. CIT 28 SOT 383 (Mum) (2009)]

  30. Section 2(22)(e)- Deemed Dividend • Non taxable accumulated capital gains- distributed to the shareholders of a company would not be dividend. • Tea Estate India P. Ltd. vs. CIT 103 ITR 0785 (1976) (SC) • Accumulated profit does not include: • Share Premium Account • Share forfeiture receipts • Capital reserve • Subsidy on capital Account • Therefore Dividend can be declared by the company only out of revenue reserves and not from the capital reserves.

  31. Cash Credit (Section 68 of Income Tax Act • Any Sum • Found credited in the book of an assessee maintained for previous year • Assessee offers no explanation about the nature and scope • OR the explanation offered by him in not in the opinion of AO, satisfactory • MAY be charged to Income tax • As the income of the assessee of that previous year.

  32. Cash Credit (Section 68 of Income Tax Act • Provided that where • Assessee is a company (closely held company) • And sum so credited consists share application, share capital, share premium or any such amount • Explanation offered by assessee company shall be deemed to be not satisfactory, unless • the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and scope of such sum so credited, AND • Such explanation in the opinion of AO aforesaid has been found to be satisfactory. • Provided further that • first proviso shall not apply if the person in whose name the sum referred to therein is recorded is Venture capital fund or a Venture capital company referred in clause (23FB) of section 10.

  33. Cash Credit (Section 68 of Income Tax Act Finance Act insert two provisos, w.e.f. 01-04-2013 First Proviso .. Enlarge the onus of closely held company and provides that if a closely held company receives any share application money or share capital or premium or like, Income tax should also establish the SOURSE OF SOURCE ( i.e. resident from whom such money is received. Second Proviso provides that first proviso will not apply if the receipt of such sum is from VCF or VCC.

  34. Cash Credit (Section 68 of Income Tax Act • There must exist books of accounts • As per Section 2(12A) of Income Tax Act books includes ledgers, day books, cash books, accounts books and other books. • In Central Bureau of Investigation v. V.C. Shukla [1998] 3SCC 410, the Supreme Court has held that loose sheets or scraps of paper cannot be termed as book for they can be easily detached and replaced. • Books of accounts must be of assessee himself • Books of account of a partnership firm cannot be considered to be the books of account of the partner. Any cash credit shown therein cannot be brought to tax as income under Section 68 in the hands of the partners.

  35. Cash Credit (Section 68 of Income Tax Act • Bank Pass book is not books of account for the purpose of Section 68. • if AO finds any unexplained transaction in the bank passbook of the assessee then same can be taxed as unexplained money under Section 69A of the act. • Additions in the Partner’s capital account • Issue : whether firm is liable to explain and whether addition can be made to firm’s income in such case under Section 68 ? • In CIT v. Metachem Industries [2000] 245 ITR 160(MP), it has been held that where the assessee-firm had satisfactorily explained the credits standing in the name of its partners, the responsibility of the assessee stands discharged. • It is open to the A.O to undertake further investigation with regard to that individual who has deposited the amount.

  36. Cash Credit (Section 68 of Income Tax Act • Provision applies to all credit entries • the language of section 68 shows that it is general in nature and applies to all entries in whomsoever name they may stand, that us whether in the name of the assessee, or a third party. • Whether in the revenue nature or capital nature. • Section does not make any distinction between commercial and non commercial transactions. • Burden of Proof • In order to discharge the onus, the assessee must prove the following • the identity of the creditor • The capacity of the creditor to advance money and • Genuineness of the transaction. • Recent Case : [CIT v. Oasis Hospitality Pvt Ltd., 333, ITR, 119, (Delhi HC,2011] • In the comprehensive survey of the law, reiiterated that the initial onus is one the assessee to establish all three of these factors.

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