2020 (12) TMI 1078 - HC - Income Tax

Court rules bonus shares' fair market value not taxable under Section 56(2)(vii)

The court dismissed the appeal by the revenue, upholding the decisions of the Commissioner of Income Tax (Appeals) and the tribunal. It ruled that the ... Taxability of bonus shares under Section 56(2)(vii) of the Income Tax Act - application of fair market value under Rule 11U/11UA of the Income Tax Rules - distinction between creation/allotment of shares and transfer of property - anti abuse object of Section 56(2) - reallocation of company funds by capitalization of reserves - no inflow of fresh funds on issue of bonus sharesTaxability of bonus shares under Section 56(2)(vii) of the Income Tax Act - application of fair market value under Rule 11U/11UA of the Income Tax Rules - distinction between creation/allotment of shares and transfer of property - reallocation of company funds by capitalization of reserves - Fair market value of bonus shares computed under Rule 11U/11UA cannot be treated as income from other sources under Section 56(2)(vii) when bonus shares are issued by capitalization of reserves. - HELD THAT: - The court held that Section 56(2)(vii) contemplates two contingencies: receipt of property without consideration and receipt for consideration less than fair market value. The issue of bonus shares by capitalization of reserves is a reallocation of the company's funds and does not involve any inflow of fresh funds or transfer of company property to the shareholder. On allotment of bonus shares the capital employed and total funds available with the company remain unchanged; the market and intrinsic value of the aggregate holding of the shareholder correspondingly adjust. Absent any material indicating that bonus shares were transferred to evade tax, no benefit accrues to the shareholder that falls within the mischief of Section 56(2)(vii). Accordingly, computing and bringing to tax the fair market value of bonus shares under Rule 11U/11UA as income from other sources is not attracted on the facts of this case.The tribunal and Commissioner (Appeals) were correct in holding that Section 56(2)(vii)(c) does not apply to the allotment of bonus shares; the addition was deleted.Final Conclusion: The substantial question of law is answered against the revenue and in favour of the assessee; the appeal is dismissed. Issues:Interpretation of Section 56(2)(vii) of the Income Tax Act, 1961 regarding the taxation of bonus shares under the head 'income from other sources'.Detailed Analysis:Issue 1:The primary issue in this case revolves around the interpretation of Section 56(2)(vii) of the Income Tax Act, specifically in relation to the taxation of bonus shares received by the assessee. The Assessing Officer treated the receipt of bonus shares as income from other sources and assessed the fair market value of the bonus shares at a specific amount. The Commissioner of Income Tax (Appeals) allowed the appeal by the assessee, stating that the provisions of Section 56(2)(vii) were not applicable to the case. The tribunal also dismissed the revenue's appeal, relying on a Supreme Court decision and concluding that the provisions of Section 56(2)(vii) were not attracted to the fact situation of the case.Issue 2:The crux of the argument presented by the revenue was that the assessee should have offered the market value of the bonus shares as income from other sources under Section 56(2)(vii)(c) of the Act since no consideration was paid for the shares. The revenue contended that the tribunal erred in its reliance on a Supreme Court decision and in determining the market value of the bonus shares. On the other hand, the assessee argued that there is no actual receipt when bonus shares are allotted, as they are created in the hands of the shareholders. The company does not transfer existing property to the allottees when issuing bonus shares, and no benefit accrues to the shareholders from such allotments.Issue 3:The court's analysis focused on the interpretation of Section 56(2)(vii) in the context of bonus shares and the fair market value computation under the Income Tax Rules. It was observed that the issue of bonus shares does not result in any fresh funds inflow or change in the capital employed by the company. The total funds available with the company remain the same, and the issue of bonus shares does not alter the company's profit-making apparatus. The court emphasized that any profit derived from bonus shares is offset by the depreciation in the value of existing equity shares held by the shareholder. Ultimately, the court concluded that the provisions of Section 56(2)(vii) were not applicable to the case as there was no transfer of property and no intention to evade tax through the issuance of bonus shares.Conclusion:In conclusion, the court dismissed the appeal by the revenue, upholding the decisions of the Commissioner of Income Tax (Appeals) and the tribunal. The court ruled that the fair market value of bonus shares computed under the Income Tax Rules cannot be considered as income from other sources under Section 56(2)(vii) of the Act in the specific context of this case. The judgment provides clarity on the taxation treatment of bonus shares and highlights the distinction between the issuance of bonus shares and the transfer of property for tax purposes.