The issue of shares at premium usually alert the tax authorities with a probable levy of angel tax under the aegis of section 56(1) of the Income Tax Act, 1961 (Act). A similar issue1 recently came for adjudication before Hon’ble Mumbai Tribunal in the case of DCIT vs Brand Marketing (India) (P.) Ltd.2 wherein the tax authorities attempted to levy angel tax on the premium generated on the conversion of compulsorily Convertible Participating Preference Shares (CCPPS) into equity shares.
The Tribunal rejected revenue’s contention of treating such transaction as sham and held that CCPPS were converted in accordance with the terms of the shareholder’s agreement and at Fair Market Value (FMV) determined at the time of issuance of shares, accordingly, such premium is not taxable as income under section 56(1) of the Act. Brief facts of the case and the issues involved are discussed hereunder.
- Brand Marketing (India)(P) Ltd (Assessee) is a company incorporated on March 23, 2006. It is engaged in the business of import and wholesale trading of branded readymade garments. The Assessee has created various subsidiaries owning numerous brands namely Calvin Klein, Gucci etc.
- During the year3 under
consideration, Assessee undertook the following transactions with
respect to its capital structure:
- Issued 15,97,742 shares of INR 10 each at a premium of INR 9/- per share, thus receiving a premium of INR 1,43,79,678/-;
- Converted 30,99,415 CCPPS of INR 220/- each to 30,99,415 CCPPS of INR 10/- each and amount of INR 65,08,81,142 (sic INR 65,08,77,150/-) was credited to the Share Premium Account;
- Further converted 23,39,181 CCPPS of INR 10 each into equity shares of INR 10/- each.
- During the assessment proceedings, the Assessing Officer (AO) treated the aggregate share premium amounting to INR 66,52,60,820/- (sic INR 66,52,56,828/-) as income taxable from other sources under section 56(1) of the Act.
- Aggrieved with the above addition, Assessee filed an appeal before Commissioner of Income Tax (Appeals) (CIT(A)) who concurred with its view and deleted the addition.
- Against the order of the CIT(A), revenue preferred appeal before Mumbai Tribunal.
- Whether premium generated on the conversion of shares and also received on the issuance of shares, taxable as income from other sources under section 56(1) of the Act?
- Based on the above facts, the act of conversion of CCPPS from face value INR 220 to INR 10 may be treated as a fresh issue of shares with a face value of INR 10 and share premium of INR 210 per share;
- Accordingly, shares had been allotted by Assessee at a premium of INR 220 per share as against the FMV of INR 10 per share in terms of valuation certificate furnished;
- Issue of shares at a premium is not justified, especially when Assessee had been incurring losses since many years;
- Further, provisions of section 78(2) of the Companies Act, 1956 (Companies Act) had not been complied with, as Assessee utilized the share premium amount for making investments in subsidiaries and towards granting loans and advances to its subsidiaries;
- Also, genuineness of the transaction, identity, and creditworthiness of the investors was not justified by the Assessee;
- The entire transaction defied the principles of commercial expediency and could be regarded as a sham device4 just to bring money in the books under the guise of ‘share premium.’ The Assessee also had no liability to repay the amount to the alleged investors;
- Bringing money in the books disguised as a share premium is in the nature of revocable transfer of assets within the meaning of section 61 to 63 of the Act chargeable to tax under section 4 and 5 of the Act;
- As per section 56(1) of the Act, income not forming part of any items of A to E referred to in section 14 of the Act shall be chargeable to income-tax under the head ‘Income from other sources.’
Assessee’s ContentionsOn Conversion of Shares
- Transaction of conversion of shares was a mere book entry without bringing any fresh money;
- The conversion was out of the CCPPS already issued in the earlier years i.e. 2007 or 2008 when shares were issued pursuant to a valid valuation of the entire business in accordance with the law applicable at the time of issuing of shares;
- The terms of conversion were mutually agreed at the time of issuance and form a part of the shareholder’s agreement;
- With respect to the AO’s contention of ‘Nil’ value of shares as per CA certificate, it submitted that the valuation certificate was based on erstwhile RBI’s Comptroller of Capital Issues (CCI) guidelines for issuing shares to non-residents. Such guidelines provided for valuation of shares at book value and profit earning capacity based on past earning;
- Since the company was fairly new, the value of its shares as per CCI guidelines was bound to be ‘Nil.’ Further, the above certificate was issued for the limited purpose of complying with RBI requirements and did not represent the fair value of the business;
- The traditional method of valuation of shares was further amended by RBI to Discounted Cash Flow (DCF) method which aptly considers the future business plans, growth prospects, future revenue-generating capacity, exclusive rights to international brands, number of retail outlets, etc.;
- AO failed to appreciate the distinction between ‘cash generated on account of the issue of shares at a premium’ and the restriction contained in section 78(2) of the Companies Act which provides for the ‘application of share premium account’;
- In view of above, provisions of sections 2(24), 56(1), 68, 61 to 63 of the Act are not applicable to the facts of the case;
- With respect to the fresh issue of shares, the Assessee relied on the judgment of Bombay High Court in the case of Vodafone India Services (P) Ltd vs Union of India5 and Rockstar Real Estate (P) Ltd vs ITO6 and Mumbai Tribunal decision in the case of Green Infra Ltd vs ITO7
- It also stated that the entire investment was approved by Foreign Investment Promotion Board of India (FIPB), and the investors were non-resident entities registered as Foreign Venture Capital Investors (FVCI) with SEBI. Necessary certificates were produced before the AO during the assessment proceedings;
- All the documents viz: - FIRCs, copy of share certificates, copy of board resolution, copy of valuation certificate, Form FCGPR, etc. were duly provided to the AO during assessment proceedings;
- Further, money was received through normal banking channels and the necessary formalities of RBI were complied with;
- AO himself held par value of shares to be genuine and only treated the premium amount of shares to be sham. A transaction could be considered a sham in entirety and not in parts;
- In contravention to the AO’s
reliance on Apex Court’s decision in the case of McDowell
(supra), Assessee relied on the Apex Court decision in case of
Union of India vs Azadi Bachao Andolan8 wherein it was
held that its decision in the case of McDowell (supra) should not
be read so as to mean that:-
- every attempt at tax planning is illegitimate and must be ignored; or
- every transaction which is perfectly permissible in law or which has the effect of reducing the burden of the Assessee must be looked in disfavor.
- In order to tax any receipt, it has to be in the nature of income, in the first place;
- Section 2(24)(xvi) of the Act defines ‘income’ to be an amount received in excess of FMV of shares as referred to in section 56(2)(viib) of the Act. Hon’ble Tribunal held that provisions of section 2(24)(xvi) and section 56(2)(viib) of the Act are applicable with effect from AY 2013-14 and not to the year(s) under consideration. Accordingly, AO’s Act of treating the share premium amount as income chargeable to tax under section 56(1) of the Act is not correct;
- In respect of the fresh issue of shares, since provisions of section 2(24)(xvi) are not applicable to the assessment years under consideration, tribunal concurred with Assessee’s reliance on Bombay HC decision in case of Vodafone India Services Ltd (supra) and Mumbai Tribunal decision in the case of Green Infra Ltd (supra) which stated that capital transactions cannot be subjected to income;
- Tribunal also held that material evidences to substantiate that the shares were issued to foreign investors, and the conversion of shares was in accordance with the terms of issue of the preference shares and appropriately justified with the fair valuation, were available; therefore there is no case treating such an issue/conversion as a means of tax avoidance;
- There is no question of any transfer of any assets or any income, as the Assessee in the present case received funds i.e., it was a transferee and not transferor so as to apply the provisions of Sec. 61 to 63 of the Act. Section 61 to 63 of the Act are applicable when income or assets are transferred with an intention to resume powers on income and assets again;
- Accordingly, both the actual premium received and premium generated on the conversion of shares was not taxable as income.
This is a unique judgment for the sole reason that it discusses in detail the issue of income addition not only of the excess money received for the issue of shares but also the excess premium generated on account of the conversion of shares. There have been judgments that give similar decisions9, but those judgments deal only with the issue of premium actually received. The judgment would also serve to be a good precedent, for it also holds that the issue of shares at higher values is justified on future business prospects, and that issue of shares at higher prices does not make the entire transaction as a sham or a colorable device. One also has to be mindful of the fact that the assessees need to maintain thoroughly documented evidences so that their intention of entering into the transaction could be explained properly at the assessment as well as the appellate levels.
1 Other issues in the appeal i.e. disallowances under sections 14A and 36(1)(iii) of the Act are not being discussed in the present tax alert.
2 [(2020) 113 taxmann.com 15 (Mumbai-Trib.)]
3 AY 2010-11, AY 2011-12 & AY 2012-13
4 For this, AO relied on the judgment of Supreme Court in the case of Mc Dowell vs CIT [(1985) 154 ITR 148 (SC)]
5 [(2014) 368 ITR 1 (Bom)]
6 Writ Petition No. 2885 of 2014
7 [(2013) 145 ITD 240 (Mum-Tri)]
8 [(2003) 263 ITR 706 (SC)]
9 PCIT vs PMP Auto Components (P) Ltd. [(2019) 416 ITR 435 (Bom)]
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