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Section 56, Taxable Incomes, FMV Determination, Anti-abuse Provision, Tax Mechanics, Exclusions, Valuation Rules
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Section 56 Direct Taxes Refresher Course- Pune branch of WIRC CA Anish Thacker 10 June 2017
Section 56- Recap Section 56(1)- Charging section- Residuary section- Taxes income not taxed under any foregoing head Section 56(2)- Incomes chargeable under the head ‘Income from Other Sources’ (i)- dividends (ia)- Section 2(24)(viii) now omitted (ib)- winnings from lotteries, crossword puzzles, etc (ic)- employee’s contribution to any provident fund, superannuation fund, etc [if not taxable under ‘Profits and Gains from Business and Profession (PGBP)] (id)- interest from securities (if not taxable under PGBP) (ii)- income from letting out on hire machinery, plant or furniture (if not taxable under PGBP) (iii)- income from letting out of building along with machinery, plant and furniture, where the same is inseparable (if the same is not taxable under PGBP) (iv)- sum received under a Keyman insurance policy (if not taxable under ‘PGBP’ or ‘Salaries’) (v)- Gift of money exceeding Rs 25,000, received by an individual or Hindu Undivided Family (HUF) before 1 April 2006 (vi)- Gift of money exceeding Rs50,000, received by an individual or HUF on/ after 1 April 2006 but before 1 October 2009 (vii) Gift of money, immovable/ movable property exceeding Rs50,000 received by an individual or HUF on/ after 1 October 2009 but before 1 April 2017 (viia)- Receipt of shares (of a company in which public are not substantially interested [CHC]) by a firm/ CHC without/ for inadequate consideration post 1 June 2010 but before 1 April 2017 (viib)- Receipt by CHC consideration for issue of shares in excess of FMV from any resident (viii)- Interest income received on compensation (ix)- Forfeiture of money received as advance or otherwise in the course of transfer of a capital asset
Section 56(2)(viib) – Taxability of CHC for receipt on issue of shares
Taxability of CHC for receipt on issue of shares-Section 56(2)(viib) • Section 56(2)(viib) was inserted by the Finance Act, 2012 w.e.f. 1 April 2013 • The Finance Minister in the Budget Speech 2012 explained the object of introduction of section 56(2)(viib) as follows: • “…… to deter the generation and use of black money, I propose to… increase the onus of proof on closely held companies for funds received from shareholders as well as taxing share premium in excess of fair market value” • Section is an anti-abuse provision aimed at arresting circulation of unaccounted money in the economy • The section seeks to tax the aggregate receipt on shares of a CHC issued for a consideration which is more than the Fair Market Value (FMV) of shares. • Section 56(2)(viib) is applicable on receipts from residents only.Accordingly, residential status of person is to be seen as per the Income-tax Act, 1961 (Act). • Treaty residence would not be relevant. Resident would include Not Ordinary Resident (NOR)
Taxability of CHC for receipt on issue of sharesMechanics for determination of FMV Determination of FMV Taxability under section 56(2)(viib) • FMV of shares is higher of the following: • Value determined in accordance with method as may be prescribed (Rule 11UA)or • Value which CHC substantiates to the satisfaction of the tax authority based on value of assets (including goodwill and other intangible) on the date of issue of shares Company (Not being a company in which public are substantially interested (CHC) Any person being a resident Any consideration for issue of shares The issue price exceeds face value of such shares Income = Consideration – FMV of shares
….General Overview - Exclusions Exclusions from the section • Issue of shares by a widely held company (WHC) • Issue of shares to a Non Resident • Issue by Venture Capital Units to Venture Capital Company/ Venture Capital Fund • Issue of securities other than shares – CCDs, warrants etc Transactions not likely to be impacted • Transfer/ receipts of shares - Buyback, forfeiture, capital reduction, liquidation etc. • No issue of share as such • Transactions without any consideration - Bonus issue, subdivision of existing shares • No consideration for issue of shares • Transactions with Inadequate consideration - Right issue, sweat equity, ESOP’s etc • Issue and conversion of CCDs/ Bonds/ CCPS etc (refer discussions in ensuing slides)
Determination of FMV of shares and securities [Rule 11UA(2)] Shares and securities Quoted shares Unquoted shares • As per Rule 11UA(1) Other than equity shares Equity shares • Option with assessee to adopt any of the two for FMV of equity shares • FMV determined as per Rule 11UA(1) Option 1 • FMV of equity shares = (A-L)/(PE) X (PV) A =Book value of assets in the balance sheet – [(TDS/ TCS/ Advance Tax) – (Refund + Deferred expenditure)] L =Book value of liabilities– (paid up equity capital + undeclared dividends + reserves & surplus + provision for taxation + provision for unascertained liabilities + contingent liabilities) PE=Total paid up equity share capital PV=Paid up value of such equity shares Option 2 • FMV determined by merchant banker* or an accountant as per Discounted Free Cash Flow Method (DCF) * Category 1 merchant banker (registered with SEBI) or a FCA (other than present statutory/ tax auditor)
Issue 1 - Year of Taxability – allotment date or receipt date Section 56(2)(viib) to trigger in year of receipt of share application (‘Year 1’) or in the year of issue of shares (‘Year 2’)? • Section 56(2)(viib) to trigger in Year 2 because: • Allotment represents acceptance of offer by shareholders to constitute a binding contract; • Application money becomes property of company after allotment [Sesa Goa Ltd v. State of Maharashtra (2009) 151 Com Case 358] • Compulsory refund if the allotment is not within a reasonable time • In case of liquidation, share application money is treated as unsecured creditor and is not treated at par with share capital • The receipt referred to in S.56(2)(viib) represents funds of the company and which is not the liability of the company Year 1 Share application received by CHC Year 2 Actual share issue by CHC
Issue 2 – Amalgamation involving nominal issue of shares Will section 56(2)(viib) be applicable on corporate re-organisations? A (Common Parent) A (Common Parent) Issue of shares of INR 10 at par WOS 1 WOS 1 WOS 2 WOS 2 Merger Value of Assets – INR 1000 Value of Assets – INR 1000 Value of Assets – INR 2000 • Issue – would section 56(2)(viib) apply for corporate reorganisations: • A provision could be taken that the provision is meant to apply only to bi-lateral transactions and corporate reorganisations should not get covered basis the following grounds of argument: • Object of the provision is to counteract tax evasive tactics • The issue of shares is a consequence of vesting of property • Consideration for issuance of shares is extinguishment of shares of amalgamating company • Failure of computation mechanism and consequential failure of charge • Value determination as of appointed date while shares issued on record date
Issue 3 – Transfer of assets in lieu of shares • Will section 56(2)(viib) apply on transfer of assets in lieu of shares ? • Reference may be taken from the SC decision in the case of Reva Investment Private Limited [(2001) 249 ITR 337] • The SC held that in a transaction which involves exchange of property, process of evaluation of two properties need to be similar and difference needs to be found by valuing both the properties on the same basis. • SC held that where value of shares matches the value of property transferred, no gift implications. A Co. Property transferred [BV =100; FMV=500]. Issue of shares at par B Co. Issue: ACO transfers assets to BCO in lieu of shares of BCO – being a transaction in the nature of exchange Book value of asset in the books of ACO is 100 but the fair market value of asset is 500 BCO issues shares of Rs. 100 at par value Would section 56(2)(viib) be applicable to B Co. on issue of shares ?
Issue 4 – Issue and conversion of CCDs into equity share at higher than FMV • Will Issue and conversion of CCDs into equity share at higher than FMV trigger section 56(2)(viib) • The implications under section 56(2)(viib) on conversion of CCDs into equity is evaluated basis the illustration below: • Issue • ICO issues CCD to ACO for INR 1,000. Fair value of shares of ICO as on the date of issue - INR 250. • The terms of CCD – For each CCD of INR 1,000, four equity shares of par value of INR 100 would be issued at INR 250. • The terms of CCD require compulsory conversion at the end of 5 years. • In the backdrop of the above facts, the matrix in the subsequent slide indicates relative implications of section 56(2)(viib) depending on the value parameters which may emerge as at the end of 5 years. I Co. Year 5 - CCDs converted to equity shares Year 1 - Issue of CCDs to ACO A Co.
Issue 4 – Issue and conversion of CCDs into equity share at higher than FMV (contd.)
Issue 5 – Issue and conversion of CCDs into equity share at lesser than FMV • Illustration - issue and conversion of CCDs into equity share at lesser than FMV attract section 56(2)(viib)? Issuance of shares upon conversion of bonds / CCDs at pre-agreed price is beyond provisions of S.56(2)(viib) for the following reasons:– • Legislative objective is to apply to a case where tax avoidance is clearly noticed • CCD terms as negotiated and agreed to initially are relevant • Fairness of the transaction should be tested on the date of formation of contract • Parties are merely working out their pre-existing rights and obligations. • Shares can be considered to have been issued as soon as there is binding covenant to allot shares on agreed terms and conditions • No consideration at the time of allotment of shares by the company • Receipt may include only actual receipts as opposed to constructive receipts • Issue of shares is implicitly at fair value (considering the sacrifice of debenture holders at the time of conversion) • The above arguments equally apply to CCPs
Othercases – Issueofsharesbynon-residentathigherthanFMV • No exemption to a foreign company receiving consideration in excess of FMV from an Indian resident • S.56(2)(viib) evaluation depends on income accruing or arising in India or deemed to be accruing or arising in India • No fictional income accrues or arises in India as the foreign company would issue shares and maintain its member’s register outside India • No tax trigger on the ground of receipt as remittance is made from India and there is no receipt in India. A Co (CHC) Outside India India Issue of shares by A Co. in excess of FMV B Co. Issue: ACO, a CHC issues shares for a consideration in excess of FMV to B Co. The shares are issued outside India and the share register is also maintained outside India. Further, The remittance on issue of such shares is received outside India Would section 56(2)(viib) be applicable to A Co. on issue of shares ?
Other cases –Conversion of preference shares into equity • Issue: • ACO is a virtual holding company of BCO. • ACO holds compulsorily convertible preference shares (CPS) of INR 10,000 The preference shares are redeemable at par. • While the shares are made compulsorily convertible, the number of equity shares to be issued is not prefixed • The parties desire to keep the terms of conversion flexible and believe that the economic value of ACO would be unchanged irrespective of whether preference share capital of 10,000 is represented by 1,000 equity shares of Rs. 10 or by 500 equity shares of Rs. 10 each issued at premium of Rs. 10 per share. • The terms of CPS contemplate compulsory conversion into equity as of 31 March 2017. • Whether section 56(2)(viib) be applicable for on conversion of CCDs into equity. Hold Co Year 1 – Issue of CCPs Year 5 – Conversion of CCPs into equity Sub Co. • Conversion of CCPS would arguably not give rise to S. 56(2)(viib) implications as of the date on which the instrument is due for compulsory conversion as there is no consideration at the time of allotment of shares by the company • S. 56(2)(viib) not likely to apply as the section triggers charge only in the year in which there is receipt of consideration for issue of shares.
Gift taxation • The Finance Act, 2017 has widened the scope of taxation of property or any sum received with or without or for inadequate consideration • Provision up to 31 March 2017 • Individual/HUFs taxable if any sum of money or property received without or for inadequate consideration in excess of INR 50,000 [Section 56(2)(vii)] • Firm or CHC taxable on receipt of issue of shares of a CHC if the same is without or for inadequate consideration in excess of INR 50,000 [Section 56(2)(viia)] • The erstwhile anti-abuse provisions were applicable only in case of individual or HUF and firm or company in certain cases. • Thus, in order to extend the scope to all taxpayers irrespective of residential status, a new section 56(2)(x) has been introduced, replacing section 56(2)(vii) and section 56(2)(viia) • Consequential amendment made in section 2(24) to include the receipts covered under section 56(2)(x) • Provision w.e.f. 1 April 2017 - Widened scope now extends to: • Firm, Limited Liability Partnership (LLP), Association of Persons (AOP), Body of Individuals (BOI), Companies (including WHC) • Discretionary Trust with corporate members • Place of Effective Management (POEM) infected resident foreign companies • Foreign companies unless protected by treaty
Gift taxation • Scope of “property” is not widened under section 56(2)(x) but kept same as defined under Section 56(2)(vii) • Changes in law as being applicable to entities other than individual and HUF • Scope widened to cover all recipients including listed companies • Covers sum of money and hence likely to extend to subvention or support which may be provided by parent/ associated enterprise • No exemption even when the benefit is from parent to subsidiary • Scope of property excludes: • Motor car • Concession in rendering of service • Grant of interest free loan • Intellectual property • Applicable valuation norms continue to get governed by Rule 11U/ 11UA • Section 49(4) is suitably amended to provide cost step up in respect of assessment made under section 56(2)(x)
Statutory carve out from section 56(2)(x)-Proviso to section 56(2)(x)
Notional taxation w.r.t. FMV of non-listed shares (Section 50CA) (w.e.f. 1 April 2018) • Notional taxation, if non-quoted shares are transferred for less than prescribed FMV • Applicable to transferor who holds shares as capital asset and not as stock-in-trade • Applies to shares which are not quoted. • Even if the company is listed and widely held. • Also, the shares can be of a subsidiary of a listed company. • The shares can be of a foreign company • Extends to any form of shares whether equity or preference. But does not cover convertible debt instrument such as CCD or warrants or right entitlement • FMV is to be determined in a prescribed manner • The prescribed manner need not match with Rule 11UA valuation, unless, the same is applied • The quoted shares is defined to mean shares listed on a recognised stock exchange and quoted with regularity and such quotation is based on current transaction made in the ordinary course of business. • Implicitly covers regularly traded shares
Notional taxation w.r.t. FMV of non-listed shares • Applies to share which even if quoted: • Is not quoted with regularity • Quotation is not based on current transaction in the ordinary course of business • Transactions which are not likely to be covered by section 50CA include: • Rights offer where some of the shareholders do not subscribe to the rights • Transfer by way of gift which is exempted under section 47(iii) • Any transfer which can qualify for exemption under section 47 or under the treaty • Section 50CA is different from section 50D as taxation under section 50D is triggered only when consideration is unascertained while section 50CA is in respect of ascertained consideration which is less than prescribed FMV • The recipient of share may suffer taxation under section56(2)(x)
Interplay of section 50CA and 56(2)(x)- Creation of double whammy An interplay of section 50CA and section 56(2)(x) can create a whammy in circumstances where property is transferred for less than fair value. If a transaction is not carved out, the transferor may suffer notional taxation under section 50CA whereas the transferee may suffer notional taxation under section 56(2)(x). Under such circumstances, taxpayers may wish to evaluate whether the option of outright gift provides mitigation as such transfer may be protected from capital gains tax by virtue of section 47(iii) and consequently from section 50CA.
Transactions where section 50CA may not apply and section 56(2)(x) may apply
Determination of FMV for ‘movable property’ [Rule 11UA(1)] Jewellery, archaeological collection, drawings, paintings, sculptures, any work of art • Purchase from registered dealer - FMV = Invoice Value • Other cases • Value exceeds Rs 50,000 - FMV = assessee may obtain the report of registered valuer in respect of the price it would fetch if sold in the open market • Value is less than Rs 50,000 – FMV = Value would fetch if sold in open market • - If stamp duty value is disputed, Assessing Officer (AO) may refer valuation to Valuation Officer as per section 50C • - If stamp duty value is revised in any appeal, revision or reference, order can be revised under section 154 as per section 155(15)
Determinationof Stamp Duty Value for ‘immovable property’ Consideration (or part) paid by any mode other than cash • Where there is difference between date of agreement (fixing consideration) and date of registration, stamp duty value on the date of agreement to be taken Entire consideration paid by cash • Stamp duty value on the date of registration to be taken Purpose • In several cases, there is a time gap between the booking of a property and the receipt of such property on registration, which results in a taxable differential (SDV on registration date is generally higher) • This provision removes hardship in genuine cases. Hence, consideration received entirely in cash excluded
Determination of FMV for ‘movable property’ [Rule 11UA] Shares and securities [11UA(1)(c)] • Quoted shares [11UA(1)(c)(a)] • Unquoted shares ([11UA(1)(c)(b)]) [to be substituted] • FMV of equity shares = (A-L)/(PE) X (PV) A =Book value of assets in the balance sheet – [(TDS/ TCS/ Advance Tax) – (Refund + Deferred expenditure)] L =Book value of liabilities– (paid up equity capital + undeclared dividends + reserves & surplus + provision for taxation + provision for unascertained liabilities + contingent liabilities) PE=Total paid up equity share capital PV=Paid up value of such equity shares • FMV of shares and securities other than equity shares FMV = Price it would fetch if sold in the open market and report may be obtained from a merchant banker or an accountant • Received through recognised stock exchange (S/E) FMV = Transaction value • Not received through recognisedS/E • No trading on such shares done on the valuation date FMV = lowest price on a date immediately preceding the valuation date on which there was trade on any recognised S/E • Other cases- lowest price of such shares on the valuation date on any recognised S/E
Draft rules for determining the FMV of unquoted equity shares The Central Board of Direct Taxes (CBDT) has issued draft valuation rules on 5 May 2017 for substituting the existing valuation rule [Rule 11UA(1)(c)(b)] for determination of FMV of unquoted equity shares for the purpose of taxation in the hands of transferee. FMV of unquoted equity shares shall be valued as (A+B+C+D - L)× (PV)/(PE) A is book value of all assets other than jewellery, artistic work, shares, securities and immovable property, as reduced by: Any amount of income tax paid, if any, as reduced by the amount of tax claimed as refund, if any, under the ITL. Any amount shown as an asset, including the unamortised amount of deferred expenditure which does not represent the value of any asset. B, C and D represent various assets held by the company whose unquoted equity shares are the subject matter of the transfer
General issues in implementation of rules Draft rules seem to retroactively apply to transactions entered post 1 April 2017 but prior to notification of these rules which may create undue hardships to taxpayers who would have relied on the erstwhile valuation guidelines for their transactions entered post 1 April 2017. Draft guidelines only refer to valuation of unquoted equity shares and not for open market price methodology for valuation of unquoted preference shares as such shares are also considered in the section 50CA of the Act. The guidelines can create conflict in respect of transactions which are covered by other provisions such as transfer pricing and other regulatory provisions.
Coverageofsecurities • Section 56(2)(x) provides that property to have the same meaning as defined in section 56(2)(vii), which inter alia includes shares and securities • Neither the terms ‘shares’ nor ‘securities’ defined in section 56. Shares : • Shares include shares of public or private company, whether equity or preference, with or without variable rights. If subject matter of receipt is shares, section 56(2)(x) will apply • Unlike section 56(2)(viia), no distinction for shares of WHC or CHC Securities: • Section 56(2)(x) does not make a reference to the Securities Contracts (Regulation) Act, 1956 (SCRA) • Where the Act does not give reference to SCRA term may be given its natural meaning. • Rule 11U(h) has bodily incorporated the meaning of securities from SCRA • If a view is taken that Rule11U(h) is not applicable, scope may extend to all instruments irrespective of whether they are transferrable or not. • Securities (other than shares) will need to take the meaning from SCRA as: • The valuation of specified asset including securities needs to be as per the prescribed rules. • Once the Rules define securities and provide valuation mechanism only for such defined securities, the charge can be regarded as perfected only in respect of such covered securities. • In any case, the restrictive scope contemplated by Rule will apply to the extent it is beneficial to the taxpayer.
Meaning of ‘sum of money’ [Section 56(2)(x)(a)] Subvention receipts by subsidiary from holding company • Prior to introduction of section 56(2)(x), the Hon’ble Supreme Court (SC) in the case of Siemens [(2016) 390 ITR 1] held that subvention receipts from parent company to recoup losses is not taxable as revenue receipts since they are voluntary receipts and are made to protect capital investment. • After introduction of section 56(2)(x) • No consideration being discharged by subsidiary to the parent • Gift taxation needs to be seen from the perspective of recipient • Since there is absence of consideration, section 56(2)(x)shall apply Receipt of subsidy • Regarded as income as per section 2(24)(xviii) • Subsidies related to depreciable assets are considered for tax purposes and generally require reduction of cost base and accordingly precluded from section 56(2)(x) • Grants received during the course of business will be subject to tax as PGBP and therefore the applicability of the IFOS chapter shall stand precluded.
Meaning of ‘sum of money’ [Section 56(2)(x)(a)] Personal obligation of one person met by another person Likely to be regarded at par with receipt of sum of money by a person whose obligation is relieved. Where the same is covered by provisions like section 2(24)(iv), section 2(22)(e) and 17(2)(iv), the same may not be taxable under the head IFOS, since they are specifically covered under other sections. Loan At the time of receipt- Not covered by section 56(2)(x) since there is a corresponding obligation to repay the loan. On waiver of loan- Madras High Court in the case of Ramaniyam Homes [(2016) 384 ITR 530] held that waiver of principal amount of loan for capital purpose is subject to tax under section 28(iv) and hence, no taxation under residual head Waiver of working capital loan specifically taxable under PGBP and hence, no taxation under residual head Where loan is based on bonafides and such loan is waived off or settled at a lower amount, it is arguable that the amount waived off cannot be regarded as constructive receipt by the borrower to trigger implications under section 56(2)(x).
Meaning of ‘sum of money’ [Section 56(2)(x)(a)] Security deposit money forfeited Taxable as trading receipt and hence, not covered by section 56(2)(x) Share application money forfeited Considered as a capital receipt and hence, not covered by section 56(2)(x) Receipt of consideration for breach committed by other parties to the contract Not taxable under section 56(2)(x) on account of the following: Payer of indemnity does not make payment out of love or affection The recipient of indemnity amount is likely to have suffered damage in the form of loss of money, loss of property, reputational loss, etc which substantiates that receipt of money is not without consideration but it lieu of adequate consideration and hence, it is not benefit akin to a gift. Receipt of non-compete fee There is presence of consideration in the form of refraining from undertaking certain activities/ business or restraining/ abstaining to share details, etc. Accordingly, not taxable under section 56(2)(x)
Fresh issue of shares Issue • Whether fresh issue of shares taxable u/s 56(2)(x)? Cross thoughts • “Receipt of property, being shares” refers to a transfer effected by one person in favour of another of a property which is already in existence in the form of shares before the contemplated transfer • ‘Allotment of shares’ does not involve transfer- SC ruling in Khoday Distilleries Ltd. vs CIT and Anr. [(2008) 307 ITR 312] • Recent controversy – ITAT decision in the case of SudhirMenon (HUF) vs ACIT [(2014) 162 TTJ 425] Indian Co Allotment of shares Person
Taxability on ‘fresh issue’ (1/3) • Section 56(2)(x) provides that “where any person ….receives…..from any person or persons…property…for a consideration [extracts with emphasis supplied] • Definition of property to include shares and securities. • For Section 56(2)(x) to apply, assessee must “receive” shares from another person • The word “receive” not been defined in the Act; therefore plain, natural, grammatical meaning to be attached. The ordinary dictionary meaning of the word “receive” shows that word “receive” supposes a transfer and consequently a transferor • This aspect is also made clear from the section when it refers to a receipt of property by an company “from any person or persons”. • This implies that the shares should be property in the hands of the “donor” who should “give” these shares to the recipient. This implies that the “property” should be existing property; only then can it be received by the recipient from the giver.
Taxability on ‘fresh issue’ (2/3) • In the context of shares, allotment takes place by way of appropriation out of previously unappropriated capital of a company, of a certain number of shares, to a person and till such allotment, the shares do not exist • In Khoday Distilleries Limited the SC explained that there is a vital difference between “creation” and “transfer” of shares. The words “allotment of shares” has been used to indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person. • There is thus a distinction between a case where there is an allotment of shares (involving a creation of a share) and a share purchase (where there is a transfer of an existing share). • Therefore, it can be said that fresh issue / allotment of shares is not covered by provisions of section 56(2)(x) • This position forms basis for many scenarios where the applicability is decided upon whether there is a ‘fresh allotment’ or ‘actual transfer’ of shares
Taxability on ‘fresh issue’ (3/3)Sudhir Menon – ITAT ruling • The Mumbai ITAT in the case of Sudhir Menon [HUF]* dealt on taxability of allotment of “additional” shares, on the basis of existing shareholding and at a value less than the fair value • The ITAT ruled that both cases of proportionate/ dis-proportionate allotment of shares falls within the ambit of the erstwhile section 56(2)(vii) • However, as regards “proportionate” allotment, the ITAT ruled that there should be no adverse tax implications as it is similar to issue of bonus shares • The ITAT has observed that a higher than proportionate allotment attracts the erstwhile section 56(2)(vii) • The decision of ITAT appears to require reconsideration and it may further also be distinguished in cases where the issuing company has no right of appropriating unsubscribed portion of right entitlement, in favour of any other shareholders/third party * ITA No. 4887 / Mum / 2013
Rights issue to existing shareholders Proportionate basis triggers implications of section 56(2)(x)? • If fresh issue is beyond scope of S. 56(2)(x) - non-applicability irrespective of proportionate or disproportionate rights allotment • If section 56(2)(x) triggers for fresh issue – Not taxable even in terms of the decision of the Hon’ble SC in the case of Dhun Kapadia (63 ITR 652) and Navin Jindal (2010-TOIL-03-SC-IT) there is no increase in percentage of holding of the shareholder as value of security received is compensated by dilution Dis-proportionate basis (not subscribed by all shareholders) triggers implications of section 56(2)(x)? • If fresh issue is beyond scope of section 56(2)(x) - non-applicability irrespective of proportionate or disproportionate rights allotment • Ratio of ITAT decision in the case of SudhirMemon (supra) could create concerns • Shares do no include right entitlements for the purpose of section 56(2)(x), • Security under SCRA includes marketable securities and rights or interests in such securities • Shares of a private company do not qualify as securities as per SCRA and therefore right entitlements in such private limited shares may not attract section 56(2)(x) • Conversely, rights entitlements in public limited shares may attract section 56(2)(x)
Disproportionate rights issueCase study • Indian Co (I Co) is held by two NRs – A Co and B Co holding 99% and 1% respectively • I Co has been set up for the purpose of acquiring business of another Indian company • The FV and FMV of I Co prior to acquisition is INR 10 • For the purpose of acquisition, I Co shall make a rights issue subscribed only by A Co and not B Co • Pursuant to this rights issue, the revised shareholding would be A Co and B Co holding 99.99% & 0.01% respectively • Will the increase in shareholding of A Co be subject to the provisions of 56(2)(x)? Conclusions – • Primarily, no trigger in case of fresh issue of shares • Owing to ITAT ruling, disproportionate rights may be subject to section 56(2)(x) • Exposure in any case should not exceed the ‘value of benefit arising’ to A Co shareholder • Thus, in this case, the exposure should not exceed 1% of the value of I Co
Buyback of shares Buyback of shares by Indian company from its shareholders • The intent of the section – to prevent the wrong abusive practice of "transferring" property at low values (and not for taxing normal transactions) • Provisions applies to shares capable of further transfer resulting in capital gains • Shares bought back cannot be transferred and must be mandatorily cancelled • Shares received upon buyback not registered in the name of the company prior to cancellation thereof (from Companies Act perspective) • Similar analogy applicable in case of capital reduction, redemption of preference shares • Provisions of section 56(2)(x) of the Act should be not applicable • Buyback of unlisted shares maybe subject to buyback tax Parent Company Buyback of shares 56(2)(x) not applicable Indian Subsidiary
Buyback of shares at less than FMV Section 56(2)(x) • Shares received by the company pursuant to buyback for cancellation has no value and cannot be regarded as less than fair consideration - SC judgement in the case of CTO vs State Bank of India (Civil Appeal No. 1798 of 2005) • Shares are never “received” by company since they may as one option be deemed to be cancelled without company receiving them. • Property is not in existence post the transfer. • Section 56(2)(x) is therefore not applicable.
