One of the primary issues that has caused an unrest among taxpayers was the applicability of the provisions on fresh issuance of shares. While the conversations on budget for the next fiscal year are in the air, expectations of several stakeholders flare up around this time of the year. While the taxpayers expect more tax reliefs, smooth assessments and speedy processing of refunds, the Government has to balance out these expectations with its own fiscal deficit and addressing largescale tax violations and leaks. Even so, it may not be transgression on the part of taxpayers if they are looking at respites from the anti-abuse mechanisms introduced on valuation of shares in genuine business cases.
The decade gone-by saw a series of anti-abuse mechanisms being introduced to curb the transfer or issue of shares either above or below their fair market value. For instance, in 2012, taxation of notional income, earned by unlisted companies through issue of shares at a price higher than the face value, was introduced through section 56(2)(viib) with an objective to discourage investments of exorbitant amounts in private companies, through equity. Similarly, under-valuation of shares on issue or transfer was also under the scanner of suspicion. Section 56(2)(viia) was introduced in 2010 to tax receipt of shares without adequate consideration whereby, tax incidence was on the transferee or recipient of such shares. This position was further strengthened in 2017 through introduction of 56(2)(x) which widened the base from shares to transfer of other assets as well. Further to this, section 50CA was also introduced which attempted to tax the difference between fair market value and the transaction value could be taxed in the hands of the seller on a notional basis.
All these measures saw retaliation from several stakeholders. The primary issue that caused unrest among taxpayers was the applicability of these provisions on fresh issuance of shares. While a notification clarifying section 56(2)(viia) would not apply to fresh issuance was issued, the same was withdrawn within a month and the applicability on fresh issuance was re-affirmed. Similarly, the applicability of section 56(2)(x) on fresh issuances is ambiguous as of date. As section 56(2)(x) is the substitute of section 56(2)(viia) and was introduced with the same intention, it could be argued that section 56(2)(x) should be applicable to fresh issuances. Section 56(2)(x) taxes shares received at fair market value minus the allotment price.
It is also pertinent to keep in mind that due to business exigencies, it may not always be possible undertake transactions at fair market values.-
Whether fresh issue could be construed as receipt of shares by the shareholder or not is a debatable issue in itself. The Supreme Court in the case of Khoday Distilleries ltd. v. CIT had clarified that a share comes into existence only on its allotment. Thus, whether allotment of a share can be equated with its receipt in the hands of a shareholder is an arguable question. Accordingly, applicability of section 56(2)(x) on fresh issuances of shares can be challenged.
It is also pertinent to keep in mind that due to business exigencies, it may not always be possible undertake transactions at fair market values. The intention behind introducing the above provisions was to have a counter-evasive mechanism in place with fair market value as the standard. Hence, it is critical to grant breathing space to genuine transactions. For instance, in cases of companies who are under the Insolvency and Bankruptcy Code, 2016 or instances where the concerned entity has a number of hidden liabilities or is going through a severe temporary cash crunch and desperately needs liquidity to pay off lenders and creditors, there may be a requirement to allot or transfer shares at a significant discount to their fair market value based on their business exigencies. The extant tax legislation do not allow such aberrations. The taxpayers may have to go through arduous litigation processes to seek clarity from the Courts. While it will be interesting to see how Courts would view such genuine transactions in the light of the existing provisions of sections 56(2)(viib), 56(2)(x), 50CA, etc., the likelihood of any clarity emerging prior to these matters reaching the Supreme Court or at least the one of the High Court seem remote. While legislative intent remains an extremely powerful theoretical argument, till the time it is used and blessed by a Court, it may not gain much reliance from the taxpayers. Under these situations, the taxpayers have no option but to hope requisite clarifications from the government about the intent of these provisions.
Taxpayers, in the interregnum, may be well advised to prepare an absolutely solid defense to substantiate and justify their transaction value and why none of the aforesaid provisions requiring them to substitute transaction values with notional values should not be applicable to their respective cases, so that they can defend themselves appropriately if their transactions are challenged.
About the Author(s): This article has been co-authored by SR Patnaik, Partner, and Akshara Shukla, Associate, Cyril Amarchand Mangaldas.
Disclaimer: The views expressed are solely of the authors and ETCFO.com does not necessarily subscribe to it. ETCFO.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.