Section 56(2) (viic) of IT Act Does Not Apply To Fresh Issuance Or Allotment Of Shares By A Company: Gujarat High Court
The bench placed reliance on a settled principle of law that what cannot be done directly cannot be done indirectly as well
The Gujarat High Court has ruled on the interpretation of Section 56(2) (viic) of the Income Tax Act, 1961, stating that the provision does not apply to fresh issuance or allotment of shares by a company.
As per Section 56(2)(viib), if a company receives, in any previous year, a consideration for the issue of shares exceeding the face value of such shares from any person, who is a resident, the aggregate consideration received for shares exceeding the fair market value of the shares, shall be deemed as income of the concerned company. It will be taxed under the head ‘Income from other Sources’ for the relevant financial year.
The division bench comprising Justice Biren Vaishnav and Justice Bhargava D Karia observed, “Regarding the issue of whether the Section 56(2)(vii)(c) of the Act can be invoked for additional 82,200 shares received by the assessee (since the wife and father of the assessee did not exercise the rights issued and renounced the right in favor of the assessee), reliance was placed on a settled principle of law that what cannot be done directly cannot be done indirectly as well.”
The ruling came in two tax appeals filed by the Revenue Department. These arose out of the judgment and order of the Ahmedabad Bench the Income-Tax Appellate Tribunal under Sec. 260-A passed in ITA No.1541/Ahd/2017 filed by the respondent-assessee and ITA No.1643/Ahd/2017 filed by the revenue department for the Assessment Year 2013-2014.
The wife and father of the assessee, considered relatives as per the exemption clause, did not exercise their rights to subscribe to the shares, effectively renouncing the rights in favor of the assessee.
The Court ruled that if they had directly transferred the shares to the assessee, Section 56(2)(viic) would not have been applicable due to the exemption for transactions among relatives. Therefore, it did not attract the provisions.
The central concern pertained to the relevance of Section 56(2)(viic), addressing the taxation of property acquired without consideration or for inadequate consideration. In 2010, a notable modification was introduced to the provision. It encompassed the transactions related to shares of companies not predominantly owned by the public.
Thus, the pivotal issue was about determining whether the issuance of new shares by a company, especially through the mechanism of right shares, fell within the scope of Section 56(2)(viic).
The bench analyzed the legislative intent behind this provision and cited the explanatory note to the Finance Bill, 2010, providing clarification that Section 56(2)(viic) was intended to be applicable exclusively in situations involving the transfer of shares.
It emphasized the fundamental distinction between the creation and the transfer of shares. The Court stated that shares were brought into existence through allotment and not transferred from one party to another. This major distinction determined that Section 56(2)(viic) should not be invoked in the context of a company's fresh issuances or allotments of shares.
The judges stated, “It is only on allotment that the shares come into existence. In every case, the words ‘allotment’ of shares is used to indicate the creation of shares appropriation out of unappropriated share given to a particular person, also referred to in the notice of clause to the Finance Bill.”
The bench added, “Therefore, the aim and intention behind amending the provision of Sec.56 was to prevent the practice of transferring unutilized shares at a price allotted for the first time by way of the right shares. The amendment never meant to aim the ‘fresh issue’ or ‘fresh allotment’ of shares by a company.”
Delving into the distribution of right shares to the taxpayer, it stated that when shares were allocated in a strictly proportionate manner, grounded in the current shareholding structure, Section 56(2)(viic) was not applicable. This was on the premise that even if the provisions were technically applicable, they would not yield unfavorable outcomes. That’s because the gains arising from the allotment of new shares counter-balanced the losses in the value of the existing shares.
On the assessee acquiring 82,200 shares through the renunciation of rights by the wife and father, the Court underscored the principle that actions deemed impermissible directly should not be allowed through indirect means.
Thus, agreeing with the valuation of shares at Rs.205.55 per share, the judges upheld the ruling of the Commissioner of Income Tax (Appeals) to determine the Fair Market Value (FMV) of the shares by referencing the previous balance sheet approved during the Annual General Meeting (AGM) of the company.