Issue Of New Shares Is Not Transfer, Section 56(2)(vii)(c) Income Tax Act Not Invokable : Gujarat High Court

The Gujarat High Court has held that the shares that have been allotted to the assessee were not “received from any person,” which is the fundamental requirement for invoking Section 56(2)(vii)(c). The property must pre-exist for application of Section 56(2)(vii)(c), which is clear from the intention of the legislature”.

The division bench of Justice Biren Vaishnav and Justice Bhargav D. Karia has observed that the words “allotment of shares” indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person who has the right to choose allotment. In the case of ‘transfer of the shares, the shares pre-existed prior to the issuance of shares by the Company as there is a vital difference between “creation” and “transfer of shares”.

The court noted that the provisions of Section 56(2) would not be applicable to the issue of new shares, which is also submitted in the explanatory notes to the Finance Bill, 2010. It is clarified that Section 56(2)(vii)(c) of the Income Tax Act ought to be applied only in the case of the transfer of shares. It is the rule of law that the allotment of new shares cannot be regarded as a transfer of shares. Therefore, in order to apply the provisions of Section 56(2)(vii)(c), there must be an existence of property before receiving it.

Section 56 explains income from other sources. Section 56 (1) states that Income of every kind which is not to be excluded from the total income shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income tax under any of the heads specified in section 14. Section 56 (2)(vii)(c) states where an individual or a Hindu undivided family receives, in any previous year, from any person or persons on or after the 1 October 2009 any property, other than immovable property, without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property. For a consideration which is less than the aggregate fair market value of the property by an amount exceeding Rs. 50,000, the aggregate fair market value of such property exceeds the consideration.

The respondent/assessee filed the return of income for Assessment Year 2013–14, declaring income of Rs. 86,94,247, which was processed. During the assessment proceedings of M/s. Kintech Synergy Limited, it was noticed that the assessee was receiving salary in the capacity of Director of the Company, and the assessee was issued two lakhs of right shares at a face value of Rs. 10 in M/s. Kintech Synergy Limited.

The assessing officer issued a reassessment notice on the ground that the correct fair market value (FMV) of shares allotted to the assessee exceeded the consideration paid for the receipt of shares. As per the provisions of Section 56(2), it should have been taxed in the hands of the assessee. The Assessing Officer computed the FMV and the shares at Rs. 255 per share and held that the differential amount of Rs. 4,90,00,000 has escaped assessment in the hands of the assessee.

The assessee filed an appeal before the CIT (A). It was contended that the assessing officer failed to appreciate that the shares were not “received” by transfer but allotted by way of right share allotment. Hence, Sec. 56(2)(vii)(c) cannot be invoked. The Assessing Officer erroneously held that the share allotment was disproportionate and the valuation of shares at Rs. 255 per share was also excessive.

The CIT(A) held that to the extent that the assessee was allotted right shares proportionate to their existing holdings, the provisions of Section 56(2)(vii)(c) were not applicable, and the fair market value for the remaining shares was held to be Rs. 205.55 per share.

The assessee and the department filed appeals challenging the order of the CIT (A) before the Tribunal.

The Tribunal partly allowed the appeal of the assessee, holding that the issue of right shares proportionate to the holding of the wife and father was not taxable under Section 56(2)(vii)(c).

The Tribunal held that had the wife and father of the assessee directly transferred their shares in favour of the assessee, provisions of Section 56(2)(vii)(c) could not have been invoked since both of them fall under the definition of “relatives”. “Relatives” are excluded from the purview of operation of Sec. 56(2)(vii)(c).

The department contended that the CIT (A) erred in law in holding the addition under Section 56(2)(vii)(c). The CIT(A) erred in law and on facts by adopting the valuation of shares at Rs. 205 per share instead of Rs. 255 per share as determined by the Assessing Officer as per Rule 11UA(1)(c)(b).

The assessee contended that the assessee’s father and wife did not exercise their right to opt for the issue and renounced the rights in favour of the assessee. Consequently, renunciation of right shares by way of not exercising the right to subscribe to them in favour of the assessee, as held by the CIT (A) and confirmed by the ITAT, would not attract the provisions of Section 56(2)(vii)(c).

The court held that the issue of new shares by the company as a right is a creation of property, and merely receiving such shares cannot be considered a transfer under Section 56(2)(vii)(c), and accordingly, such a provision would not be applicable to the issuance of shares by the company in the hands of the allottee.

Counsel For Petitioner: Varun K.Patel

Counsel For Respondent: B S Soparkar

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

LL Citation: 2023 LiveLaw (Guj) 166

Case No.: R/TAX APPEAL NO. 80 of 2023

Click Here To Read The Order