Income Tax Act | Section 56(2)(Viic) Not Applicable To Fresh Issuances Or Allotments Of Shares By A Company: Gujarat High Court

The division bench of Justices Biren Vaishnav and Bhargava D Karia observed, “With regard to the issue whether the section 56(2)(vii)(c) of the Act can be invoked in respect of 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 favour 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 above ruling came in two tax appeals filed by the revenue arising out of the common judgement and order by the Income-tax Appellate Tribunal Ahmedabad Bench, under Sec. 260-A of the Income-tax Act, 1961, passed in ITA No. 1541/Ahd/2017 filed by the respondent- assessee and ITA No. 1643/Ahd/2017 filed by the appellant – revenue for the Assessment Year 2013-14.

The wife and father of the assessee, who are considered to be the relatives as per the exemption clause, did not exercise their rights to subscribe to the shares, effectively renouncing these rights in favor of the assessee.

The court ruled that if they had directly transferred these shares to the assessee, Section 56(2)(viic) would not have been applicable due to the exemption for transactions among relatives, and therefore, the renunciation of right shares by the wife and father in favor of the assessee did not attract the provisions of Section 56(2)(viic).

The central concern under consideration pertained to the relevance of Section 56(2)(viic) of the Income Tax Act, addressing the taxation of property acquired without consideration or for inadequate consideration. A notable modification was introduced to this provision in 2010, encompassing transactions related to shares of companies not predominantly owned by the public.

The pivotal issue in this instance revolved around determining whether the issuance of new shares by a company, especially through the mechanism of right shares, falls within the scope of Section 56(2)(viic).

The Court, in its judgment, analyzed the legislative intent behind this provision.

The court, in its decision, cited the explanatory note to the Finance Bill of 2010, providing clarification that Section 56(2)(viic) was intended to be applicable exclusively in situations involving the transfer of shares.

Emphasizing the fundamental distinction between the creation and transfer of shares, the court highlighted that shares are brought into existence through allotment and are not transferred from one party to another. This pivotal distinction formed the basis for the court's determination that Section 56(2)(viic) should not be invoked in the context of a company's fresh issuances or allotments of shares.

The Court said, “Therefore, it is only on allotment that the shares come into existence. In every case, the words “allotment of shares” having used to indicate the creation of shares appropriation out of unappropriated share given to a particular person which is also referred to in the notice of clause to the Finance Bill 2010.”

“Therefore, the aim and intention behind amending the provision of Sec.56 is to prevent the practice of transferring unutilized shares at a price which are allotted for the first time by way of right shares. The amendment is therefore never meant to aim the “fresh issue” or “fresh allotment” of shares by a company,” the Court added.

Turning to specific facets of the case, the court delved into the distribution of right shares to the taxpayer.

In its judgment, the court determined that when shares are allocated in a strictly proportionate manner, grounded in the current shareholding structure, Section 56(2)(viic) is not applicable. The court's rationale rested on the premise that even if the provisions were technically applicable, they would not yield unfavorable outcomes. This is because the gains arising from the allotment of new shares counterbalance the losses in the value of existing shares.

Concerning the matter of 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.

Ultimately, the court agreed with the valuation of shares at Rs.205.55 per share. It upheld the CIT(A)'s ruling to determine the Fair Market Value (FMV) of the shares by referencing the previous balance sheet approved during the Annual General Meeting (AGM).

Appearance: Mr.Varun K.Patel, Senior Standing Counsel With Mr. Dev D. Patel, Advocate For The Appellant(S) No. 1 Mr B S Soparkar(6851) For The Opponent(S) No. 1

LL Citation: 2023 LiveLaw (Guj) 188

Case Title: The Principal Commissioner Of Income Tax 1, Ahmadabad Versus Jigar Jashwantlal Shah)

Case No.: R/Tax Appeal No. 80 Of 2023

Click Here To Read The Order / Judgement