TAX TALK-16.05.2011-THE HITAVADA

TAX TALK
BY CA. NARESH JAKHOTIA
(Chartered Accountant)
“ISSUE OF SHARES BELOW THE FAIR MARKET VALUE: INVESTOR LIABLE TO PAY INCOME TAX”

In the last issue of Tax Talk dated 09.05.2011, we have elaborated the provision of section 56(2) (vii). It was opined therein that “Issue of shares below the fair market value would be taxable as income from other source”.

In response to our opinion, we have received few feedbacks doubting the taxability of difference between the Issue Price and Fair Market Value as Income. We are very happy to see the feedback & divergent views given by the active readers of our column. We appreciate the comment provided by our vigorous Readers.

The three main divergent views expresses in the feedback were:
1. Section 17 (2) of Income tax governs taxation of shares allotted or transferred to the employee by the employer or former employer, free of cost or at a concessional rate. It is taxed by an express & clear provision as perquisite whereas nothing specific is there in section 56 (2)(vii) and 56(2)(viia).
2. Section 56(2)(vii) & section 56(2)(viia) governs taxation of movable property (including shares) received by an individual, HUF, Firm or company from any person or persons, in so far as it refers to property being shares, following conditions precedent must be fulfilled-a] Property being shares must be in existence.b] Property being shares must be received (allotment excluded)c] Property being shares must be received from any person or persons.Thus, this section purports to tax, transaction in the pre-existing shares held by the entity, other than the Company. If the legislature had intention to tax issue of shares by allotment by the Companies it must have used the word “receipt by allotment”. This point comes clear from the explanations to memorandum of Finance Bill, which reads as under: -“In order to prevent the practice of transferring unlisted shares at price much below their fair market value, it is proposed to amend section 56 to also include within its ambit transaction undertaken in shares of a company (not being a company in which the public are substantially interested) either for inadequate consideration or without consideration”
3. Shares as a Property Shares in the Company represent entitlement of a shareholder against the Company, Shares in the issuer Company is not a property held by that Company. In Khoday Distilleries Ltd. Vs CIT (2008) the Supreme. Court has expressed that “The Company does not own and cannot own its shares. It becomes property in the hands of allottee. Prior thereto does not constitute goods.”The legislature has used and employed the words ‘Property being ‘purposefully with the intention of covering the shares which have already in existence and not an issue of shares by the Company having regard to the provision of Companies Act 1956.as well as the law laid down by the Supreme Court, which the legislature is aware of.In the view of what is stated above, allotment of shares by a company, does not give rise, to taxable event. It has never been the intention of legislature to tax allotment of shares to non-employees. The Finance Minister has made this point clear in the explanation to Memorandum. It is well settled canon of taxation that for taxing the citizen, the legislature has to make express provision. Using the word allotment in section 17 (2) and excluding this word in section 56(2) (vii) 56(2) (viia) should make the point clear beyond doubt.

With this feedback, to have a better understanding, we need to revisit the original provision.

Section 56 (2)(vii) specifies the following receipt taxable as income from other source as under:
(vii) Where an individual or a Hindu undivided family receives, in any previous year, from any person or persons on or after the 1st day of October, 2009,-
a) Any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;
b) Any immovable property, without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property ;)
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 property as exceeds such consideration:

The word “Property” is a much wider terms. The explanation to section 56 has duly elaborated the meaning of the word “Property” so as to include the shares & securities as well within its ambit. It would be improper to conclude that shares are not included in section 56(2) vis a vis section 17(2).

Issue/Allotment of shares by a company pre-supposes the existence of rights of the company to issue such shares embedded in the Authorised share capital of the company. What is being transferred is a RIGHT which gets crystallized in to Shares after Allotment. The views that the shares should be in existence so as to be taxable u/s 56(2)(vii) & (viia) may not impress the Assessing Officer.

Further it may be noted that Shares in a company are certainly a form of property. The wide definition of “property” in section 6 of the Transfer of Property Act includes not merely shares as transferable, moveable property, but would cover, as a separate form of property, a right to obtain shares which may be antecedent to the accrual of rights of a shareholder upon the grant of a share certificate in accordance with the Articles of a Company. It was so held by the Apex court in Vasudev Ramchandra Shelat Vs. Pranlal Jayanand Thakar (1975) 45 Comp cas 43 (SC).

It may further be noted that the stipulations like “(a) Existence of shares (b) Shares must be received (allotment excluded) (c) shares must be received from any person/ persons” cannot be supposed to be originating directly from the provision of section 56(2)(vii) / 56(2)(viia).

At the cost of repetition, the clause (d) to section 56(2)(vii) is reproduced hereinbelow:
d) Any property, other than immovable property,-
iii) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;
iv) 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 property as exceeds such consideration:

Undisputably there will be a unanimous consensus that there is a difference between the intention with which this provision was introduced and the actual result the section is yielding. It is correctly pointed out by the Readers that the explanatory memorandum to the Finance Act-2010 (AND NOT EXPLNATORY MEMORANDUM TO THE FINANCE ACT-2009 which has introduced section 56(2)(vii)]conveys the intention of the legislature to cover the TRANSFER of shares only and not fresh issue of shares by the company itself. The words “In order to prevent the practice of transferring unlisted shares at price much below their fair market value……………..” will always carry the required weightage in such cases.

Perhaps, reader will recall the careful opinion drawn by us vide Tax Talk dated 09.05.2011 as under:
“Whereas the intention of the Government while enacting the above provision would have been to essentially tax transfer of shares of private companies for inadequate consideration, the way the proposed amendment is worded will make RIGHT ISSUE, preferential issues & most of the acquisitions also taxable in the hands of the Investor.

We, at Tax Talk, always believe that precaution & safeguards are always better. We also try to remain the tax neutral from either side, be it the Assessee or the Income Tax Department. The views expresses above are our personal views & still the divergent views are possible on the issue. The Income Tax Department, by & large, may take the view favorable to the revenue, at least, when the strict & plain interpretation of the statue is in favor of the Revenue. May be in time to come, the provision will be settled by the Judiciary. In the overall interest, we request CBDT to kindly clear the air by coming out with the suitable clarifications on the issue.

Comments

  1. Sir
    In light of above analysis when shares issued at lower of FMV is taxable, then why bonus share received (if FMV exceeds Rs 50000) wont be taxable u/s 56. In 09.05.11 talk u have opined that issue of Bonus shares is not at all taxable in the hands of recipient. The same is neither taxable as “Capital Gain Income” nor as “Income from Other Source”. But bonus shares are issued without any consideration.

    ReplyDelete
  2. Thank you for this valuable information.. however please let me know will Section 56 (2) vii C be applicable in case of right issue by a company??

    ReplyDelete

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