FORTIFYING THE DIMENSION OF SECTION 56(1)
The legislative intent of the Income-tax Act, 1961 (Act) has always been providing taxation of income. The term "income" is defined under the provisions of the Act to charge certain receipts, but over a period of time, its ambit has been extended to tax receipts such as non-compete fees, fair market value (FMV) of property received without consideration, etc.
One of the reasons why the Government enlarged the scope of "income" under the provisions of the Act was to curb the generation, circulation and accommodation of unaccounted money. With this objective, the Finance Act, 2012 introduced the provisions of section 56(2)(viib) under the Act. These provisions attempt to tax excessive premium infused in a closely held company. The said provision provides as follows:
Where a company, not being a company in which the public are substantially interested;
receives any consideration for issue of shares from a person resident in India;
where such consideration exceeds the face value of the shares, then;
the consideration received over and above the FMV of the shares shall be taxable in the hands of the company.
As per the provisions of section 56(2)(viib) of the Act, the FMV of the shares is determined as follows
Adjusted net asset value or discounted cash flow (DCF) method; or
Any other methodology, as may be substantiated to the satisfaction of the Assessing Officer (AO).
Recently, the Hyderabad bench of the Income tax Appellate Tribunal (ITAT) in the case of Apollo Sugar Clinics Ltd. (the Company) has examined the question of taxability of the excessive premium received on issue of shares under section 56(1) in case of non-applicability of specific deeming provision of section 56(2)(viib).
In the instant case, the Company was a stepdown subsidiary of a listed company, and consequently, for income tax purposes, was considered to be a company in which the public are substantially interested i.e. a widely held company. During the first year of its operations, the Company had issued equity shares to two resident Indian companies at a price that was higher than the FMV computed based on the DCF method of valuation.
During the assessment proceedings, the AO asked the Company to justify and substantiate with evidence such high share premium in the first year of its operations itself.
The Company argued that the valuation report was obtained by it for regulatory/ non-financial reporting purposes and that in a commercial transaction, the parties have the liberty to mutually agree on the transaction price. It therefore argued that the FMV of the shares depicted in the valuation report is indicative and that it does not have any bearing on the price at which such shares are issued.
It also argued that section 2(24) of the Act, which defines the term "income", provides that only such excess premium as referred to in section 56(2)(viib) of the Act can be treated as income. Thus, if such premium is not covered by section 56(2)(viib), then such receipt cannot be termed as "income". The Company also argued that the provisions of section 56(2)(viib) are not applicable, as it is a widely held company.
However, the AO argued that where the method for determining the FMV of shares has been specified, the Company is not at liberty to determine its own price. The Company may have used negotiations and deliberations during the transaction, but the provisions of the Act are very specific regarding the issue of shares at premium.
Further, the AO argued that as per provisions of section 56(1), for income of every kind that is not to be excluded from the total income and that is not chargeable to tax under any other heads of income, such income shall be subject to tax under section 56(1). Accordingly, though in the present case, the provisions of section 56(2)(viib) shall not apply, and the excess premium shall be taxable under section 56(1).
On an appeal, the CIT (A) upheld the order of the AO and taxed the excess premium received in the hands of the Company under section 56(1) of the Act.
The ITAT, while passing its order, considered that section 56(1) deals with "income" of every kind that does not fall under any other head. On the other hand, section 56(2) deals with income that is otherwise not an income but has been specifically brought under the definition of "income" by the legislature.
Relying on the decision of the Supreme Court in the case of Mercantile Corporation vs. CIT, the ITAT held that where there is a specific provision introduced by the legislature to bring to tax any specific receipt, then such receipt cannot be taxed under the general provisions of the Act. In the present case, the receipt of excess premium is a capital investment, and hence, it cannot be subject to tax under section 56(1) of the Act.
The above decision of the ITAT reaffirms the following settled principles:
Only a receipt that is an "income" in terms of section 2(24) can be brought to tax; and
Where there is a specific provision, the general provisions cannot be invoked.
It is well understood that any capital receipt, unless so specified (e.g. capital gains), cannot be brought to tax. Securities premium is also a capital receipt; however, it can be taxed as it is covered by section 2(24)(xvi) provided that it passes the test under section 56(2)(viib). If the test under section 56(2)(viib) fails, then such receipt cannot be charged to tax by invoking the general provisions of section 56(1).
* This article includes inputs from Nirav Mehta - Manager, M&A Tax, PwC India and Devansh Shah - Associate, M&A Tax, PwC India.
Disclaimer:The views expressed in this article are personal.The publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.
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