TaxTMI 
TaxTMI 
TaxTMI 
2024 (2) TMI 1035
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.... and sustained by the CIT-Appeal is unjustified, unwarranted and uncalled for. 2. On the facts and in the circumstances of case, the CIT(A) has erred in sustaining order of the A.O., where in the Ld. Assessing Officer has erred in invoking provision section 56(2)(viib) r.w.r. 11UA of the Income Tax Act. The Invoking provision of section 56(2)(viib) r.w.s. 11UA(1) by the A.O sustained by the CIT-A is unjustified, unwarranted and uncalled for. 3. On the fact and Circumstances of the case, the CIT(A) has erred in sustaining the order of the A.O, wherein the A.O. has erred in making addition, without issuing the show cause notice which is against the principle of natural justice. The order passed against the principle of natural justice as well as proper opportunity of being heard is bad in law and deserves to be annulled. 4. The appellant reserves the right to add, amend or alter any grounds of appeal at any time of hearing." 2. Succinctly stated, the assessee company which is engaged in the business of a builder and developer, had e-filed its return of income for A.Y.2017-18 on 31.10.2017 declaring an income of Rs.11,84,54,270/-. The return of income filed by the assessee ....
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....m Pvt. Ltd. Equity shares 2,73,000 27,30,000 2,73,00,000 3,00,30,000 2. Anand Singhania Preference shares 5,72,700 57,27,000 5,72,70,000 6,29,97,000 3. Priyank Singhania Preference shares 2,05,000 20,50,000 2,05,00,000 2,25,50,000 10,50,700 1,05,07,000 10,50,70,000 11,55,77,000 The A.O, on a perusal of the details, observed, that though the assessee company as per Rule 11UA of the Income Tax Rules, 1962 had furnished a valuation certificate of the equity shares issued by it but had not furnished any such details/certificate for the preference shares that were issued by it. On being queried, the assessee submitted that since no specific method of valuation of preference shares in the case of a private company was prescribed in the Act, hence the value of equity shares had been taken as the value for the preference shares. However, the A.O. did not find favor with the aforesaid explanation of the assessee company. Referring to Rule 11UA of the Income Tax Rules, 1962, the A.O. observed that the "Net Asset Value" ("NAV", for short) method that was used by the assessee company for valuing the equity shares could not have been adopted for v....
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....ee company. 6. After rejecting the value of the preference shares that was disclosed by the assessee company, the A.O reworked out their value @ Rs.5/- per share as against that taken by the assessee @110/- per share, observing as under: "14. In light of the above discussion, the valuation taken by the assessee for the preference shares issued to Sh. Anand Singhania and Sh. Priyank Singhania cannot be accepted. Valuation of the preference shares is being calculated on the following basis: The following assumptions have been made to arrive at this valuation. a) That looking at the history of dividend payment which is nil in the last so many years, and also the fact that as per the subscribed conditions that dividend would be paid to the preference shareholders only when it is also paid to the equity shareholders, it is assumed that the assessee pays 10% dividend every alternate year b) That it is redeemed at the end of 20 years at the same value i.e. 110 c) That the discounting is made at 12%, which is the risk-adjusted rate for preference share which is non-cumulative and it is not secured against assets. The going rate for secured debt is about 10-11% and that for e....
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.... non-redeemable in nature. The share holders reserves the right to vote, share profit and claim assets of the company. On the other hand the preference shares are shares with dividends that are paid out to shareholders before common stock dividends are issued. Preference shares are securities which can be thought of as being mid-way between debt and equity. Preference shareholders do not get a variable return. Rather they get a fixed rate of return like debt holders. Thus, a preference share holder does not face the risks of an equity shareholder and also does not get the slow return of a bond holder. It is somewhere in between these two extremes. For that reason, payments to preference shares are not legally mandatory. If the company makes a profit, they must receive their fixed dividend before the ordinary shareholders are paid. Dividends, in case of preference shareholders are fixed. Hence, there need not be any speculation as to what the pattern of dividend payouts will. Whether, it will be constant as in the case of the dividend discount model or whether they will grow at a constant rate like in Gordon growth model. The cash flow timings and amounts are almost certain in case ....
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....resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be deemed to be the income of the concerned company chargeable to tax under the head Income from other Sources for the relevant financial year. Further, the FMV shall be determined as per the methods prescribed under Rule 11UA(2) of the Income-tax Rules, 1962 (Rule). For ready reference, the relevant extract of Rule 11UA(2) is reproduced as under:- (2) Notwithstanding anything contained in sub-clause(b) of clause (c) of subrule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares. as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:- (a) fair market value of unquoted equity shares = (A-L) *(PV)/(PE) A= book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax p....
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....of ordinary equity. Thus, the AO was fully justified in placing secured debt instruments on same footings with preference shares. Therefore, DCF method is most appropriate one for determining true value as per characteristic of the preference shares. This method should have been adopted by the appellant. But the appellant adopted NAV method which is not meant for valuation of preference shares. During the appellant proceedings, the appellant has also furnished valuation of preference shares as on 31.03.2016 & 05.04.2016 by adopting NAV method but not submitted the value as per DCF method as adopted by the AO. Thus, the appellant failed to prove that the valuation done by the AO was incorrect. 3.1.4 Furthermore, the Act does not specify any specific method for determining face value of preference shares, however, provisions of section 11UA(1)(c) of the Act defines that the fair market value of unquoted shares shall be estimated at a price which it would fetch in a open market on the valuation date. To determine that, the best and mostly adopted method for valuation of preference shares is DCF method which has been adopted by the AO. Further, provisions of section 56(2)(viib) does....
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.... we set-aside the matter to the file of the AO who shall determine the value of the preference shares as per the NAV method based on formula discussed above and such valuation has to be determined as on the date of issuance of such preference shares. In the result, the ground of appeal is allowed for statistical purposes. 3.1.5 Form the above cited decision, it is abundantly clear that the Hon'ble ITAT has directed the AO to determine value of preference shares as per NAV method for the reason that the NAV method was never disputed in the said case, however, in the case of the appellant the NAV method has been rejected from the grass root level i.e. by the AO itself. Therefore, the facts of the case of M/s Ginny Global (supra) are entirely different and distinguishable from the case of the appellant. It is settled legal proposition that in the case of dispute arising out in any situation, the widely used concept should be adopted. As discussed herein above, the preference shares hold nature of debt instrument, therefore, the DCF method which is widely used and most appropriate for determining fair market value is to be adopted in the case of appellant, as adopted by the Id A....
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.... method and I do not find any infirmity in the order of the AO. Thus, the addition made by the AO amounting at Rs.8,16,58,500/- is confirmed. Therefore, appeal on these grounds is dismissed." 8. The assessee being aggrieved with the order of the CIT(Appeals) has carried the matter in appeal before us. 9. We have heard the ld. Authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the Ld. AR to drive home his contentions. 10. Controversy involved in the present appeal lies in a narrow compass, i.e. as to whether or not the preference shares issued by the assessee company to S/shri Anand Singhania and Priyank Singhania (supra) @ Rs.110/- per share was at Fair Market value (FMV)? 11. Before proceeding any further, we deem it fit to cull out the provisions of Section 56(2)(viib) of the Act, which at the relevant point of time read as under: "56(2) In particular; and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income tax under the head "income ....
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....uced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortized amount of deferred expenditure which does not represent the value of any asset; L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:- (i) the paid-up capital in respect of equity shares; (ii) the amount set apart for payment of dividends on preferences shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; (iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation; (iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (v) any amount representing provisions made for meeting liabilities, other than ascertained l....
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.... for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities; (vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares PE= total amount of paid up equity share capital as shown in the balance sheet; PV= the paid up value of such equity shares; or (b) the fair market value of the unquoted equity shares determined by a merchant banker as per the Discounted Free Cash Flow method;" (emphasis supplied by us) 12. Shri Vijay Mehta, Ld. Authorized Representative (for short 'AR') for the assessee company to buttress his claim that both the lower authorities had grossly erred in dislodging the valuation of the preference shares which was rightly disclosed by the assessee company, had come forth with multi-facet contentions, viz., (i). that as S....
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....ertion of Section 56(2)(viib) of the Act was explained, submitted that the Hon'ble Supreme Court in the case of K.P Varghese Vs. ITO (1981) 131 ITR 597 (SC), had held, that the intent and purpose for making available a statutory provision can safely be gathered by referring to the Budget Speech of the Finance Minister while introducing the finance bill. The Ld. AR submitted that as in the present case, the subject preference shares had been allotted by the assessee company to its director and ex-director, viz. S/shri Anand Singhania and Priyank Singhania, wherein the identity and creditworthiness of both the shareholders, as well as the genuineness of the transactions of allotment of shares were proved beyond doubt therefore, the provisions of Section 56(2)(viib) of the Act, i.e. an anti-abuse provision could not have been triggered and brought into play for drawing adverse inferences in the hands of the assessee company. 14. Shri Vijay Mehta, Ld. A.R, submitted that now when the transactions of allotment of subject preference shares by the assessee company to its aforesaid director/ex-director had been tested and found to be genuine business transactions, i.e. without any element....
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....he ITAT, Delhi in the case of BLP Vayu (Project -1) (P) Ltd. Vs. PCIT (201 ITD 283) (Del.), Page 158 to 165 of APB. It was submitted by the Ld. AR that as in the case before the Tribunal shares were allotted by the assessee company to its 100% holding company, therefore, it was observed that based on a schematic interpretation the deeming provisions of Section 56(2)(viib) of the Act could not have been triggered in such a situation. The Ld. AR had further drawn our attention to the order of the ITAT, Raipur in the case of Chhattisgarh Metaliks and Alloys (P) Ltd. Vs. ITO, ITA No.102/RPR/2019 dated 26.07.2022, Page 166 to 185 of APB. In the aforesaid order, the Tribunal after taking cognizance of the CBDT Circular No.10/2018 dated 31.12.2018 which was thereafter withdrawn, had observed, that as the aforesaid statutory provision was introduced as an anti-abuse measure to prevent the laundering of unaccounted money, therefore, the same being a counter tax evasion mechanism to prevent the laundering of unaccounted money could not have been triggered in the case of issuance of bonus shares, allotting of shares to existing shareholders in proportion to their existing shareholding (akin t....
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....port of his aforesaid contention had drawn our attention to the order of the ITAT, Bengaluru in the case of Information Technology Park Ltd. Vs. ITO, ITA Nos. 1357 and 1358/Bang/2018 dated 24.08.2022, Page 194 to 205 of APB. Referring to the aforesaid judicial pronouncement, the Ld. AR submitted that in the said case, the "Net Asset Value" (NAV) method that was adopted for valuing the preference shares was not disputed by the Transfer Pricing Officer (TPO), who had applied the same method to work out the valuation. In fact, the controversy before the Bench had arisen only concerning the value of land and building that was considered by the TPO for arriving at NAV. The Ld. AR submitted that the Tribunal in the aforesaid case, had observed that on a conjoint reading of sub-clause (b) and (c) of Section 11UA(1)(c), it can safely be gathered that for valuation of preference shares, the guideline value of the immovable property was to be adopted since the same represented economic and commercial value of the preference shares on the date of value. Also, the Ld. AR submitted that the aforesaid observation of the Tribunal read a/w. the fact that the A.O/TPO had adopted NAV method for dete....
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.... would pay 10% dividend, submitted that now when the terms of allotment of preference shares in itself provided for 100% dividend (i.e. coupon rate of 100%), and the assessee company had a substantial amount of divisible profits of Rs.27 crore as on 31.03.2016, therefore, there was no justification for the A.O to have assumed payment of 10% dividend. Also, the Ld. AR pointed out perversity in the assumption of the A.O. that the dividend would be paid by the assessee company every alternate year. The Ld. A.R, referring to the observation of the A.O. that the assessee company had no dividend payment history, submitted that it was incomprehensible as to how the same would be relevant regarding the dividend that would be payable by the assessee company in the future period. The Ld. AR, to fortify his aforesaid contention, submitted that an investor at the stage of investing looks at the potential of the company as to whether or not it can pay a dividend in the future, and also, certain other factors like convertibility into equity shares, redemption premium, etc. The Ld. AR submitted that the A.O. had as per his convenience failed to consider all the aforesaid factors, and most arbitra....
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....). The Ld. DR submitted that the CIT(Appeals) had rightly upheld the view taken by the A.O, and the contentions advanced by the Ld. AR in his attempt to dislodge the well reasoned observations of the lower authorities being devoid and bereft of any merit, therefore, did not merit acceptance and were liable to be rejected. 23. We have heard the ld. authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the Ld. AR to drive home his contentions. 24. As observed by us hereinabove the controversy involved in the present appeal boils down to the solitary issue, i.e. as to whether or not the A.O is right in law and facts of the case in rejecting the valuation of the preference shares that were issued by the assessee company to S/shri Anand Singhania and Priyank Singhania, i.e director and ex-director by adopting the "Net Asset Value" method, and substituting the same by "dividend discounting method"?. Also, as a corollary flowing thereto, another aspect that emerges from the aforesaid controversy is as to whether or not, the ....
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....tax evasion provision, at first blush appeared to be convincing, but going by the rule of strict literal interpretation that has to be adopted while construing the scope and gamut of a statutory provision the same does not merit acceptance. As Section 56(2)(viib) does not carve out any exception as regards the applicability of the same in a case where the shares are issued to the directors of the company, therefore, the aforesaid contention of the Ld. AR that the same would not apply to the preference shares issued by the assessee company to its director/ex-director cannot be accepted. Apropos the support drawn by the Ld. AR from the judgment of the Hon'ble Supreme Court in the case of K.P Varghese Vs. ITO (supra) to impress upon us that the scope of applicability of Section 56(2)(viib) of the Act that has been made available on the statute vide the Finance Act, 2012 w.e.f. 01.04.2013 should be gathered in the backdrop of the budget Speech of the Finance Minister while tabling the Union Budget for 2012-13, the same, we are afraid would not carry the case of the assessee company any further. The Hon'ble Apex Court in the case of K.P Varghese Vs. ITO (supra) had, inter alia, held tha....
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....opted by the assessee company for determining the FMV of the subject preference shares, but at the same time, he had vehemently assailed the observations/assumptions based on which the A.O. had determined/estimated the FMV of the preference shares as per "dividend discounting method" at Rs.5/- per share. Because the assessee company had called into question the factual observations of the A.O while determining the FMV as per the "dividend discounting method", therefore, we shall chronologically deal with the same as under: (i). Redemption of preference shares at the end of 20 years at the same value i.e. Rs.110/- 30. As observed by us hereinabove, the A.O., in the body of the assessment order, while determining the FMV of the subject preference shares had proceeded on the basis that the said shares were redeemable at the end of 20 years at the same value of Rs.110/-. Before us, it is the claim of the Ld. AR, that the aforesaid observation of the A.O. is fallacious and incorrect. Elaborating on his aforesaid contention, the Ld. AR had submitted that the subject 7,78,000 nos. of 100% noncumulative redeemable preference shares issued by the assessee company were redeemable not late....
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....subject preference shares have been issued by the assessee company, it transpires that as per the "Special Resolution" passed in the Extraordinary General Meeting of the assessee company on 04.04.2016, it was specifically provided that the said preference shares shall be redeemed on not less than Rs.110/- each; or it shall be converted into a similar number of fully paid up equity shares by obtaining permission from all preference shareholders. For the sake of clarity, the relevant extract of the resolution is culled out as under: "6. The said shares shall be redeemed on not less than Rs.110/- each or it shall be converted into a similar number (i.e. number of preference shares to be issued) of fully paid-up Equity shares by obtaining permission from all preference shareholders." (emphasis supplied by us) As in a case where the preference shares are convertible into equity shares, the fair market value of such shares would be more than the non-convertible preference shares or debt instruments, therefore, we find substance in the claim of the Ld. AR that the A.O. had grossly erred in losing sight of the material fact that the subject shares were optionally convertible non-cumul....
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....not be treated as a simpliciter debt instrument. Accordingly, we find substance in the contention of the Ld. AR that there is no justification for the A.O. in treating preference shares as a debt or a quasi-debt instrument, and thus, consider the discounting rate on that basis for estimating the FMV of the subject preference shares. Also, we find substance in the Ld. AR's contention that the bank FDR rate as was prevailing during the year in question should have been taken as the appropriate rate of return. (v). Subscription of the preference shares by the promoters of the assessee company 35. On a perusal of the assessment order, it transpires that the A.O while framing the assessment had, inter alia, observed that as the subject preference shares have been issued by the assessee company to S/shri Anand Singhania and Priyank Singhania, i.e. Managing director/Ex-director of the assessee company, therefore, the value at which they have subscribed to the shares could not be taken to be a market value of the preference shares. 36. We have thoughtfully considered the aforesaid observation of the A.O, and though concur with him that subscription of the shares by related persons may ....
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....nce shares were quasi-debt instruments, which were differently placed in comparison to equity shares, therefore, the FMV of the same could not be determined in the manner that applied to equity shares. The A.O. was of the view that unlike the preference shareholders while the equity shareholders were the real owners of the company, the preference shareholders who had no stake over the assets of the company were only vested with a preference over the equity shareholders on repayment of equity. Accordingly, the A.O. was of the view that the "Net Asset Value" (NAV) method which represented the value of equity shares could not be adopted for determining the FMV of the preference shares. 40. We shall now look into the sustainability of the aforesaid view of the A.O. by carrying out a conjoint reading of Section 56(2)(viib) of the Act and Rule 11UA of the Income Tax Rules, 1962. 41. As per the "Explanation" to Section 56(2)(viib) of the Act the FMV of the shares shall be the value, viz. (i) as may be determined in accordance with such method as may be prescribed; or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date....
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....t on the valuation date and is supported by a report obtained from a merchant banker or a specified accountant. Accordingly, there is merit in the Ld. AR's contention that the applicability of "Explanation (a)(i)" to Sec. 56(2)(viib) which provides that the FMV of the shares be determined in accordance with the methods as may be prescribed is confined to the determination of FMV of unlisted equity shares, and, the same fails as regards determining the FMV of preference shares. Based on his aforesaid contention, the Ld. AR has claimed that the determination of FMV of preference shares would be as per the mandate of "Explanation (a)(ii) of Sec. 56(2)(viib), i.e.- based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature of the assessee company. The Ld. A.R, based on his aforesaid contention had supported the determination of FMV of the subject preference shares by the Chartered Accountant of the assessee company, i.e, as per "Net Asset Value" (NAV) method. As observed by us hereinabove, the Ld. A.R. had submi....
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....o be obtained from the public market for similar types of financial securities. Although the assessee claims that as the subject preference shares are optionally convertible preference shares, convertible into a similar number of equity shares of the assessee company, therefore, essential characteristic on the exercise of the conversion option is that of equity shares, and hence Net Asset value (NAV) method for valuation of these shares need to be considered, but we are unable to accept the said contention. As the subject shares are optionally convertible non-cumulative redeemable preference shares, which, as observed by the A.O in the body of the assessment order, as per the terms and conditions on which they have been issued by the assessee company, inter alia, in the event of winding up shall not be entitled to its assets, therefore, their FMV in our view cannot be safely determined based on the "Net Asset Value" (NAV) method. At the same time, we are of the view that the fact that the subject shares are optionally convertible preference shares would in itself be a primary factor to be considered in the backdrop of the unlisted equity shares, and thus, will have a strong bearing....