[Opinion] Taxation issues for closely-held companies for share premium amounts received

V. K. SUBRAMANI – [2022] 140 taxmann.com 399 (Article)

The Gift Tax Act, 1958 was abolished from 1st October, 1998. Many taxpayers realised the consequence of such abolition and took advantage of the same by arranging their affairs in such a manner that could minimise their income-tax liability. Except clause (iv), clause (vi), clause (vii) and clause (viii) of section 64(1) there was no check on transfer of assets / income inter se among the family members / relatives except of course, section 64(2) meant for taxation of personal assets when mixed with HUF properties.

It took a while for the lawmakers to understand the apparent vacuum because of the repeal of the Gift Tax Act and hence inserted necessary provisions in section 56(2) vide Finance (No.2) Act, 2004 w.e.f. 01.04.2005. Subsequently, section 56(2) underwent changes regularly to block any scope for circumventing the taxation of (deemed) incomes and it is almost fully accomplished by the legislature.

Section 56(2)(viib) inserted by the Finance Act, 2012 w.e.f. 01.04.2013 proves to be a right measure in respect of corporate entities which are closely held i.e. not being a company in which public are substantially interested. This refresher takes note of an excellent treatise on the relevant legal provisions provided by the Kolkata Bench of the ITAT in the case of Milk Mantra Dairy (P.) Ltd. v. Dy. CIT [2022] 140 taxmann.com 163 (Kol.- Trib) decided on 04.07.2022 for the very first assessment year of application of section 56(2)(viib).

1.1 Facts of Milk Mantra Dairy (P) Ltd

The assessee in this case issued 13.40 lakhs equity shares of Rs.10 each at premium to various parties including venture capital funds, non-residents being angel investors. The face value of shares was R.134.06 lakhs and share premium was Rs.1611 lakhs aggregating to Rs.1745 lakhs (approx.) received by the assessee-company. The Assessing Officer was of the opinion that the equity shares were issued over and above the FMV and accordingly, applied the provisions of rule 11UA(2)(a) by adopting Net Asset Value (NAV) method and added the entire amount of Rs.1745 lakhs as under the head “Income from other sources” of the assessee under section 56(2)(viib) of the Act.

The Assessing Officer while applying the NAV method calculated it at negative Rs.294 per share and thus adopted the value as ‘nil’ and taxed the entire amount including the face value of the shares as income. The assessee went on appeal before CIT (Appeals) who took note of the fact that the assessee had issued shares to non-residents and section 56(2)(viib) is applicable only in respect of proceeds received from residents and accordingly, gave a relief to the extent of Rs.924 lakhs. Also, he gave the relief equal to the face value of the shares being Rs.134.06 lakhs. The assessee apparently got partial relief to the extent of Rs.1058 lakhs out of the total addition of Rs.1745 lakhs. Subsequently, the assessee went before the tribunal for relief in respect of Rs.687 lakhs sustained by CIT (Appeals) and at the outset, it may be noted that the Revenue was not in appeal before the tribunal.

1.2 Legal Provisions

Section 56(2)(viib) says where a company, not being a company in which public are substantially interested, receives from a resident any consideration for issue of shares that exceeds face value of shares, the aggregate consideration received to the extent it exceeds the fair market value, is chargeable to tax.

Proviso to section 56(2)(viib) says that the provisions would 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 specified fund; or (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

It is noteworthy that further proviso to section 56(2)(viib) says that if clause (ii) of the first proviso is applicable to a company and which fails to comply with those conditions prescribed therein and has received consideration which exceeds the fair market value, it shall be deemed to be the income chargeable to income-tax and it shall also be deemed that the company has under reported its income in consequence of misreporting referred to in sub-sections (8) and (9) of section 270A.

Explanation to section 56(2)(viib) says the fair market value shall be (i) the value as determined in accordance with such method as prescribed (refer rules 11U and 11UA); or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer based on the value, on the date of issue of shares, of its assets including intangible assets – whichever is higher.

The term ‘venture capital company’, ‘venture capital fund’ and ‘venture capital undertaking’ have to be assigned meaning as provided in clauses (a), (b), (c) of Explanation to section 10(23)(FB).

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