Hiten Kishor Chande, ACA
Brief: In recent times, far reaching changes have been brought about inIncome Tax law in relation to transactions involving transfer of sharesof companies. These changes have increased the burden on the shoulders of tax payers as every time transactions involve issue or transfer of shares of unlisted companies, there are tax implications either in the hands of recipient of such shares or, issuer or transferor of such shares. Therefore, tax payers have to be careful while entering into these transactions.
Introduction:
From F.Y. 2009-10 onwards, amendments have been made in Income Tax Act, 1961 ("Act") in relation to transactions which involves transfer of shares of companies, especially, companies in which public is not substantially interested, generally referred as unlisted/closely held companies. Flurry of amendment was started by Finance (No. 2) Act, 2009 with insertion of section 56(2)(vii), followed with insertion of section 56(2)(viib) by Finance Act, 2010, which was followed by introduction of section 56(2)(viib) and amendment to section 68 by Finance Act, 2012, and finally, trend was completed with entry of Section 115QA in latest Finance Act, 2013. Prime reason for devising all these sections, was to tap the unaccounted money being flushed into the system through issue and transfer of shares of closely held companies and secondly, to counter the tax avoidance practices carried out, using shares as a device to negate the tax liability.
With this introduction, Let us have a look at the crucial changes made in the Act,
I. Section 56(2)(vii):
1) This section was introduced by Finance (No.2) Act, 2009 w.e.f. 1st October 2009 which provides as under:
"Where an individual or a Hindu undivided family receives, in any previous year, from any person or persons on or after the 1st October, 2009
(a) x x x x x
(b) x x x x x
(c) any property, other than immovable property,-
(i) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;
(ii) For a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such propertyas exceeds such consideration."
Further, property has been defined in clause (d) of Explanation to include "shares and securities".
2) Section 56(2)(vii) is a charging section which creates the charge on a transaction by providing that where assessee receives the shares at a value lower than its FMV then, gain made by the assessee on receipt of such shares will be chargeable as income of the previous year. Such a benefit is not considered as an Income in common parlance therefore, sequential amendment is also made in section 2(24) of the Act, defining such a transaction as income of the assessee. It is pertinent to note that taxable event is defined as receipt of shares by the assessee. Word 'receive' is very wide in scope to cover all kinds of receipt, whether shares are received after Purchase, or after subscription to shares, or received in settlement or compromise of any dispute, or pursuant to any transaction. Here, main purpose was to curb the practice of conducting off market transactions in shares of listed and unlisted companies at lower than market price as it used to result in circulation of unaccounted money, for this reason taxable event is defined very broadly to cover all types share transactions. However, charging section is so wide that at times, it may cover a genuine transaction within its trap without there being any allegation about unaccounted money.
3) Coming back to the topic, if such shares are received for a consideration lower than the fair market value then, difference would be taxable in the hands of recipient of shares. Further, it would be pertinent to note that like other section in this series apply to only unlisted companies, section 56(2)(vii) also applies to shares of company in which public is substantially interested i.e. Listed companies also. Therefore, in a situation where a listed company decides to issue right shares to existing shareholders at discount, say Rs. 300, lower than the Market price, say Rs. 350 then, difference between the issue price and Market price on the date of receipt of those shares will be taxable in the hands of assessee.
4) However, taxability will be different in case where Bonus shares are received by the aseesee. Because, on issue of bonus shares, price of original shares falls equivalent to value gained in the form of Bonus shares thus, value is gained at the cost of value forgone of original shares. This value forgone in case of original shares will be treated as Consideration within the meaning of section 56(2)(vii) of the Act. Word "Consideration" is not defined in the Act therefore, adopting a plain and natural meaning, it would encompass within its scope any reciprocate transfer of money or money's worth, or any value forgone by the assessee for receipt of shares; Therefore, in my view, there will be no tax implications in the hands of assessee as value gained in the form of bonus shares is offset by the fall in the value of original shares, resulting into zero income in the hands of assessee.
5) Let us have a look at the following example to understand it.
For e.g. Mr. X holds 100 shares of Y Ltd. Company decides to issue 2 bonus shares for one share held. Before issue of shares Market price of the company was Rs. 300 as a result of bonus issue price came down to Rs.100.
| Value of 100 shares before Bonus issue | : | Rs. 30,000 |
| Value of 100 shares after Bonus issue | : | Rs. 10,000 |
| Fall in the value of original shares | : | Rs. 20,000 |
| Value of Shares 200 shares after Bonus issue | : | Rs. 20,000 |
| Difference between Consideration and FMV | : | Nil |
6) Similarly, there will be no tax implication in case of issue of right shares or bonus shares in case where company is an unlisted company because, as per Rule 11UA (Net asset value/No. of shares issued) is taken as the FMV of shares. As after the issue of right or bonus shares denominator increases and value gained in the form of additional shares is offset by the fall in the value of original shares.
7) In case where company issues shares for consideration other than cash, say, in compromise or settlement of dues to creditors or borrowers, then, recipient must ascertain the FMV of shares on the day receipt vis -a- vis amount that was receivable or due from the company; income will be chargeable only in case where difference is Positive.
8) Above provisions of section 56(2)(vii) are applicable to all the Individual & HUF whether resident or non-resident. Further, there are certain exceptions where it is received from specified persons, or under certain circumstances, it is not taxable in the hands of recipient. Which tax payers must refer to before deriving any conclusion. After debut of section 56(2)(vii) on the same line, section 56(2)(viia) was introduced to tax the gain made by the Partnership Firm or Closely held company on receipt of shares another closely held company i.e. at a consideration lower than FMV.
II. Section 56(2)(viib):
9) This section was brought on the statute book by Finance Act, 2012 to tax the share premium received in excess of FMV of the shares issued by unlisted companies. Intention behind insertion of this section is to bring the unaccounted money within the tax net, which is generally pumped into the economy through floating of closely held companies. Lets us have a look at the provisions to have a better understanding:
"where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:
Provided that this clause shall not apply where the consideration for issue of shares is received—
(i) by a venture capital undertaking from a venture capital company or a venture capital fund; or
(ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf."
10) Language of the above section is similar to section 56(2)(vii) & (viia). With introduction of this section, legislature has tried to cover both the ends of transaction. Hence, in a situation where closely held company issues shares at a price lower than FMV (as per Rule 11UA), difference will be taxable in the hands of shareholders u/s 56(2)(vii) of the Act; however, if company decides to issue shares at premium without ascertaining the FMV of shares then premium exceeding such FMV will be taxable in its own hands under this section. Therefore, it must be ensured by the company that shares are issued at FMV otherwise one of the party to the transaction will have to bear the brunt of section 56(2) of the Act.
11) However, excess premium over FMV will not be chargeable to tax, if share subscription money is received from a non-resident; this condition is inserted to protect the foreign investments coming into India. One still wonders, on what basis Income tax department has charged the tax in recent case of Shell India, where subsidiary in India had issued the shares to Parent company at less than FMV. Further, to avoid the ill consequences on venture capital projects, Venture capital companies are also exempted from the clutches of above provision.
III. Section 68-cash credits:
12) After shares have been issued at FMV, the ball does not stop rolling; after passing the hurdle of section 56(2)(vii) company falls in the trap of section 68 of the Act. Section 68 is a penal provision, which brings to tax any credit amount found unexplained by the Assessing officer (AO) in the books of accounts of the assessee. In the past, there was dispute between the Income tax department and tax payers regarding the taxability of amount received towards subscription of shares, where source of capital was established by the company by giving details of shareholders like Name, Address, PAN, etc, however problem arose when no confirmation was received from the shareholders by AO and in certain cases notices remained undelivered therefore, AO taxed such amount in the hands of companies.
13) Finally, controversy was put at rest by Supreme Court in the case of CIT vs. Lovely Exports Pvt. Ltd. (2008) (216 CTR 195) wherein their lordships held that no amount could be taxed in the hands of assessee company where names and address of shareholders are given to AO. As a resort to above problem, income tax department can tax the alleged shareholders by reopening their cases in accordance with law. To overrule the above judgment of Apex court, a proviso to section 68 was inserted by Finance Act, 2012 as under:
"Provided that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless—
(a) 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 source of such sum so credited; and
(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory"
14) Above proviso has once again thrown the ball in the court of assessee by stating that amount received towards share capital will be treated as income of the company, unless shareholder also explains about the source of such amount contributed towards share capital. Thus, if shareholder is unable to prove the source of such money then instead of charging the shareholder to tax, company will be brought within the tax net. Hence, onus of proving the source of money of shareholder is entirely shifted on the shoulders of company by legislature, opposed to what was ruled by Supreme Court in the case of Lovely Exports (Supra).
IV. Section 115QA- Tax on Distributed Income of Domestic company for Buy-Back of shares:
15) This section was inserted by Finance Act, 2013 to counter the tax avoidance practice mainly adopted by Indian subsidiaries to distribute dividend to Mauritius based Holding company under the garb of Buyback of shares. Under Income Tax Act, buyback of shares is taxable u/s 46A in the hands of shareholders. However, taking the benefit of Article 13 of India-Mauritius DTAA, which provides for capital gain arising on transfer of shares of Mauritius resident taxable in that country and under Mauritius tax laws capital gain is totally exempt, entire transaction used to escape the tax net. Thus to plug this loop hole in the statute, section 115QA is introduce to provide that where shares are bought back at a price higher than the price at which those shares were issued then, balance amount will be treated as distribution of dividend and Tax @20% will be payable by the Company. Section 115QA is applicable only to domestic unlisted companies. Let us have a look at the provisions of section 115QA:
"(1) Notwithstanding anything contained in any other provision of this Act, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares (not being shares listed on a recognised stock exchange) from a shareholder shall be charged to tax and such company shall be liable to pay additional income-tax at the rate of twenty per cent on the distributed income.
Explanation.—For the purposes of this section,—
(i) "buy-back" means purchase by a company of its own shares in accordance with the provisions of section 77A of the Companies Act, 1956
(ii) "distributed income" means the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares."
16) On perusal of above provision, it can be observed that section 115QA overrides all the section of the Act and it is a seperate charging section which taxes amount distributed on buy back of shares. Further, tax under this section is in addition to tax payable under normal provisions of the Act.
17) Explanation to the section provides for the computation of distributed income, which states as under:
Distributed Income= Consideration paid on buy back – amount received on issue
On careful reading of clause (ii) of Explanation which provides for computation of distributed income, it can be observed that only shares which are issued for cash are covered within the purview of distributed income which indicated from the words "amount which was received" employed in the section.
18) It would be imperative to note that section 115QA employ the words "amount which was received which is different from words "Consideration received" used in different sections above. Hence, the intention is to tax the amount distributed to the shareholders who have subscribed to the shares for cash. Therefore, in a situation, where shares bought back were issued for consideration other than cash or were issued in settlement of any claims then, in such a case computational provision would fail consequently, charging section cannot be effectuated and amount distributed to shareholders, to whom share were issued for consideration other than cash, will not be brought to tax as held by Supreme court in case of CIT vs. B.C.Srinivasa Setty (1981) (128 ITR 294).
19) Question may also arise that where shares are issued for consideration other than cash value for the purpose of above section shall be taken as 'Nil'. In that case also computation provision would fail as the words "amount which was received" are not qualified by the words "If any". Further, words "which was received" again points to the situation where money was received at the time of issue of shares. Combining this with the absence of words "Consideration received" would indicate that intention of the legislature is to consider only those shares which were issued for cash therefore, amount distributed to such shareholders would escape the taxation.
Conclusion:
Purpose behind enacting above provisions is to deter the circulation of unaccounted money in the economy and inhibit the tax evasive practices of tax payers; however above provisions have far reaching consequences and impact of it is felt beyond its intendment. At this juncture, it would be worthwhile to remember the words of Blackstone, who beautifully explained the complexity involved in enactment of any statute,
"In general law all cases cannot be foreseen, or if foreseen cannot be expressed; some will arise that will fall within the meaning, though not within the words of the Legislation, and others which may fall within the letter may be contrary to the meaning, though not expressly expected. These cases thus out of the letter, are often said to be within the equity of an act of Parliament, so cases within the letter are often out of the equity."
Regards
Prarthana Jalan
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