Taxability on Issue of Right Issue of Shares by Unlisted Public Company

[Hithik]

Dear Experts,

In the case of a rights issue of shares at a price lower than the FMV as determined under the prescribed Rules, would the allotment of such shares be regarded receipt of property for the purposes of the relevant provisions of Section 92 of Income Tax Act 2025, thereby attracting tax implications?

Considering the above CBDT circulars Circular No. 10/2018 dated 31 December 2018, Circular No. 2/2019 dated 4 January 2019, along with the judicial precedents on the interpretation of the term "receives", can it be concluded that shares allotted pursuant to a rights issue, even if issued below FMV, would not attract the provisions of Section 92?

Thank you in advance!!

[Sanjeev Agarwal]

Yes, but the conclusion should be restricted to a genuine proportionate rights issue.

Position under Section 92, Income-tax Act, 2025

Section 92 substantially carries forward the erstwhile Section 56(2)(x) framework. It can tax receipt of specified property, including shares, for consideration below prescribed FMV where the statutory threshold is crossed.

On a literal reading, therefore, shares issued below FMV could potentially create exposure. However, a proportionate rights issue has strong judicial support for non-applicability.

Judicial position

In Sudhir Menon HUF v. ACIT - 2014 (3) TMI 534 - ITAT MUMBAI, the Mumbai ITAT held that proportionate allotment of rights shares below Rule 11UA FMV did not attract the corresponding Section 56 provision.

The rationale is commercially significant:

• rights shares are allotted proportionately to existing shareholders;
• the shareholder's proportionate interest remains substantially unchanged;
• any apparent benefit in the new shares is offset by dilution in the value of the existing holding; and
• consequently, there is no real accretion of wealth of the nature targeted by the provision.

The Supreme Court in Khoday Distilleries Ltd. v. CIT - 2008 (11) TMI 16 - Supreme Court has also recognised the conceptual distinction between allotment/creation of shares and transfer of already existing shares.

CBDT Circulars

Circular No. 10/2018 dated 31 December 2018 supported the view that the expression "receives" should not ordinarily cover fresh issuance of shares, including rights shares.

However, an important qualification is that Circular 10/2018 was withdrawn by Circular No. 2/2019 dated 4 January 2019. Therefore, Circular 10/2018 should not be treated as presently binding CBDT clarification.

Accordingly, the stronger basis for the position is statutory interpretation read with judicial precedent, rather than Circular 10/2018 itself.

Conclusion

A defensible position can be taken that a bona fide, proportionate rights issue to existing shareholders, even where the issue price is below prescribed FMV, should not ordinarily attract Section 92.

However, this conclusion should not automatically extend to:

• disproportionate allotments;
• additional shares subscribed because other shareholders renounced/did not exercise rights; or
• arrangements effectively transferring economic value to selected shareholders.

Such cases carry materially greater Section 92 exposure and should be separately tested.

AI Summary

Proportionate rights issues below fair market value may avoid taxability where no real economic benefit accrues to shareholders.
A bona fide proportionate rights issue to existing shareholders, even at a price below prescribed fair market value, is presented as generally outside Section 92 where no real economic accretion arises. The shareholder's proportionate interest remains substantially unchanged, and the apparent benefit in newly allotted shares is offset by dilution in the existing holding. This position does not automatically extend to disproportionate allotments, subscriptions following renunciation or non-exercise of rights, or arrangements transferring economic value to selected shareholders.