2025 (5) TMI 813 - AT - Income Tax

Revenue's appeal dismissed as AO incorrectly applied Rule 11UA using FMV instead of book value for share acquisitions

ACIT, Central Circle-1, Maharashtra. Versus Nakul Markhedkar

ACIT, Central Circle-1, Maharashtra. Versus Nakul Markhedkar - TMI The core legal questions considered by the Tribunal in these appeals pertain primarily to the applicability and interpretation of section 56(2)(vii)(c) of the Income Tax Act, 1961, read with Rule 11UA of the Income Tax Rules, 1962, in the context of valuation of shares acquired indirectly through holding companies. Specifically, the issues addressed include:1. Whether the acquisition of shares of holding companies at nominal value, which indirectly results in acquisition of shares of a subsidiary company with a significantly higher fair market value (FMV), attracts income tax under section 56(2)(vii)(c) as income arising from property received for consideration less than FMV.2. The correct method for determining FMV of unquoted shares under Rule 11UA applicable for assessment years prior to AY 2018-19, particularly whether the FMV of underlying assets (including shares held by the company) should be taken at book value or at FMV.3. The validity of the Assessing Officer's (AO) approach in treating the transaction as a sham transaction and applying the amended Rule 11UA retrospectively for AY 2015-16 and AY 2016-17.4. Whether the addition made by the AO under section 56(2)(vii)(c) based on the difference between the FMV of the subsidiary's shares and the nominal consideration paid for the holding companies' shares is justified.5. The applicability of judicial precedents regarding sham transactions and valuation methods under Rule 11UA.Issue-wise detailed analysis:Issue 1: Applicability of section 56(2)(vii)(c) on indirect acquisition of shares at less than FMVThe AO found that the assessee and family members acquired shares of holding companies (M/s Farista Financial Consultants Pvt Limited and M/s Deb Suppliers & Traders Pvt Limited) at nominal value (Rs. 10 per share), which indirectly resulted in acquisition of shares of the subsidiary company (M/s Ratangiri Financial Advisory Pvt Ltd, later renamed M/s Vikran Engineering & Exim Pvt Ltd) whose FMV was significantly higher (Rs. 483 per share). The AO concluded that this acquisition was a colourable device to circumvent tax provisions and constituted a sham transaction. He invoked section 56(2)(vii)(c), which taxes the difference between FMV and consideration paid when property is received for less than FMV.The AO relied on extensive material collected during search and seizure operations, including evidence that the share capital and premium of Rs. 14.03 crores raised by RFAPL were non-genuine and routed through shell companies operated by accommodation entry operators. The AO applied the 'substance over form' doctrine and held that the transaction lacked commercial substance and business purpose other than tax evasion, thus failing both the objective and subjective tests for sham transactions.Key precedents cited by the AO included the Supreme Court's decisions in McDowell & Co. Ltd. vs. CTO, Jiyajee Rao, Vodafone International Holdings, and the Bombay High Court's Killick Nixon Limited case, which reinforce the principle that sham transactions or colourable devices to evade tax are liable to be disregarded.Issue 2: Correct method for determining FMV under Rule 11UA applicable for AY 2015-16 and AY 2016-17The AO applied Rule 11UA as amended w.e.f. 01.04.2018, which requires that the FMV of underlying assets, including shares and securities, be taken at FMV rather than book value. This led to inflating the FMV of the holding companies' shares by considering the FMV of the subsidiary's shares (RFAPL) at Rs. 483 per share rather than their book value.The CIT(A) and the Tribunal held that the amended Rule 11UA was not applicable for AY 2015-16 and AY 2016-17. The Rule in force for these years prescribed valuation of unquoted shares based on book value of assets and liabilities as appearing in the balance sheet, explicitly excluding FMV of underlying shares. The Tribunal extracted and analyzed the relevant provisions of Rule 11UA(1)(b) as applicable for the years in question, which formulaically determines FMV as (A - L) x (PV)/(PE), where A and L represent book values of assets and liabilities, respectively.The Tribunal noted that the AO himself had computed the FMV of shares of the holding companies at Rs. 7.67 and Rs. 8.15 per share based on book value, but erroneously used the FMV of the subsidiary's shares (Rs. 483) to compute the addition. The Tribunal held that this was a misapplication of the Rule and inconsistent with the statutory framework for the relevant years.Judicial precedents supporting this interpretation included the Delhi High Court's decision in PCIT vs. Minda SM Technocast Pvt. Ltd. and the Tribunal's own decision in Smiti Holding & Trading Company Pvt. Ltd. vs. PCIT, which held that the amended Rule 11UA applies only from AY 2018-19 onwards and that for earlier years, valuation must be based on book value without substituting FMV of underlying assets.Issue 3: Validity of AO's approach in treating the transaction as sham and applying amended Rule 11UA retrospectivelyThe AO's conclusion that the transaction was a sham was based on the absence of commercial substance, the use of shell companies, and the manipulation of share capital and premium. While the Tribunal did not dispute the AO's findings on the sham nature of the transaction, it emphasized that the tax addition must still be made in accordance with the correct legal provisions and valuation methodology applicable for the relevant AY.The Tribunal held that the AO's application of the amended Rule 11UA retrospectively was incorrect and that the addition could not be sustained on this ground alone. The Tribunal also noted that the AO's calculation of addition, which assumed the assessee indirectly acquired 72,215 shares of RFAPL by holding 50% shares in the holding company, was not consistent with the method prescribed under Rule 11UA.Issue 4: Justification of addition made under section 56(2)(vii)(c) based on difference between FMV of subsidiary's shares and nominal consideration paid for holding companies' sharesThe AO made an addition of Rs. 3,48,29,845 by calculating the difference between the FMV of RFAPL shares (Rs. 483 per share) and the nominal consideration paid for shares of the holding companies. The Tribunal found this approach flawed because it did not apply the prescribed formula under Rule 11UA for the valuation of the shares actually acquired (i.e., shares of the holding companies) but instead used the FMV of the underlying subsidiary's shares.The Tribunal held that the correct approach would be to determine the FMV of the shares of the holding companies as per Rule 11UA applicable for AY 2015-16 and compare it with the actual consideration paid. Only if the FMV of the holding companies' shares exceeded the consideration paid would the difference be taxable under section 56(2)(vii)(c). The AO's method of attributing the FMV of the subsidiary's shares to the holding companies' shares was not supported by law.Issue 5: Treatment of competing arguments and final conclusionsThe Revenue contended that the transaction was a sham and that the CIT(A) erred in deleting the addition merely on the ground of incorrect application of Rule 11UA. The Revenue urged that the substance of the transaction should prevail over form and the addition should be upheld.The assessee argued that the CIT(A) correctly applied the law by holding that the amended Rule 11UA could not be applied retrospectively and that the FMV of underlying assets had to be taken at book value for the relevant AY. The assessee relied on judicial precedents supporting this interpretation.The Tribunal agreed with the assessee's contention on the applicability of Rule 11UA and valuation methodology, emphasizing that even if the transaction was a sham, the addition must be computed in accordance with the correct legal provisions. The Tribunal also found that the AO's calculation of addition was not in line with Rule 11UA's prescribed formula and that the CIT(A) correctly deleted the addition.For AY 2016-17, the Tribunal applied similar reasoning, noting that the AO again applied the amended Rule 11UA incorrectly and upheld the CIT(A)'s deletion of the addition.Significant holdings and core principles established:'From the plain reading of the above rule which is applicable for the year under consideration it is clear that for the purpose of determining the FMV of the unquoted shares, the underlying asset including assets in the form of shares are to be valued at book value as appearing in the Balance Sheet. This provision of considering the value of underlying asset being shares is amended w.e.f. 01.04.2018 to provide that the value of the underlying asset being shares need to be considered at FMV as determined in the manner provided in rule 11UA and not the book value as per Balance Sheet.''The AO has not only considered the FMV value per share of the underlying asset in the books of M/s Farista Financial Consultants Pvt. Limited but has also considered the number of shares alleged to be indirectly acquired by the assessee. Therefore the point of dispute is what should be the value of underlying assets that has to be considered while arriving at the FMV of the shares of M/s Farista Financial Consultants Pvt. Limited as per Rule 11UA of the Rules.''Rule 11UA as in force in AY 2013-14 does not provide to replace fair value of quoted shares to book value and therefore, the value derived by the DCIT 4(1)(1) cannot be substituted to the value as derived under Rule 11UA. Rule 11UA, during the relevant period, provides for valuation of unquoted equity shares by adopting the amount as per book value.''The difference between the FMV of the shares RAFPL and the purchase consideration paid by the assessee for obtaining shares in M/s Farista Financial Consultants Pvt. Ltd. which is added by the AO under section 56(2)(vii)(c) in our view does not fall within any method prescribed under the Act.''In view of these discussions and considering the facts unique in assessee's case we see no infirmity in the order of the CIT(A) in deleting the addition made under section 56(2)(vii)(c).''The appeals of the revenue for AY 2015-16 & 2016-17 are dismissed.'The Tribunal thus established the principle that the valuation of unquoted shares for the purpose of section 56(2)(vii)(c) must be made in accordance with the Rule 11UA as applicable for the relevant assessment year, and that the amended provisions effective from AY 2018-19 cannot be applied retrospectively. The Tribunal also clarified that the FMV of underlying assets (including shares) must be taken at book value unless the amended rule applies. Furthermore, the Tribunal underscored that even in cases involving sham transactions, tax additions must be made strictly as per the statutory valuation framework and not by applying an inflated FMV inconsistent with the law.