TaxTMI 
TaxTMI 
2026 (9) TMI 701
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....h. For the FCCDs, the assessee obtained a valuation from a registered valuer under the DCF method, determining the value at Rs. 703.89 per share. However, for the equity shares, an internal DCF valuation had determined the value at Rs. 352 per share. The AO noticed substantial variation between the two valuations made within the same financial period and proposed to tax the excess amount received on FCCDs from resident investors u/s 56(2)(viib) of the Act i.e. over and above Rs. 352 per share. 3.1 The assessee submitted that due to Covid-19, its business was adversely affected, and it incurred substantial losses. The equity shares were issued to raise immediate funds for continuing the business. 3.2 The amount raised through equity shares was relatively small. Therefore, the subsidiaries were valued at their investment/book value. These subsidiaries had not yet started operations. Hence, their projected future cash flows were not considered. 3.3 In contrast, the FCCDs were issued for a much larger amount of about Rs. 18.15 crore for investment in subsidiaries, expansion of business, repayment of loans and meeting emergency funding requirements. Therefore, the expected cash....
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....t 1,10,505 FCCDs had been issued to resident investors at Rs. 704 each. After adopting the FMV at Rs. 352.60, he treated the difference of about Rs. 351.40 per FCCD as excess premium. Accordingly, an addition of Rs. 3,88,31,457 was made as income from other sources u/s 56(2)(viib) of the Act. 4. The aggrieved assessee preferred an appeal before the learned CIT(A). 5. Before the learned CIT(A), the assessee submitted that the FCCDs were valued by an independent registered valuer using the DCF method. The valuation was made in conformity with the International Valuation Standards issued by the International Valuation Standards Council. The registered valuer was recognised and governed by the IBBI. The FCCDs were issued for investment in subsidiaries, expansion of the assessee's business, repayment of loans and other funding requirements. Therefore, the valuation made by the independent registered valuer could not be rejected merely by comparing it with an earlier internal valuation made for issue of equity shares. 5.1 The assessee further submitted that section 56(2)(viib) of the Act read with Rule 11UA prescribes specific methods for determining the FMV of equity shares, in....
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.... 5.6 The assessee further relied upon judicial precedents of Hon'ble Supreme court in the case of CIT vs. Bharat Engineering and Construction Co. reported in [1972] 83 ITR 187 to contend that capital receipts cannot be taxed unless specifically brought within the charging provisions of the Act. Further relied on the ruling of Karnataka High court in the case of Wipro Ltd v. DCIT reported in 62 taxmann.com 26 that hybrid financial instruments must be examined according to their true character rather than merely equated with equity shares. Accordingly, it was submitted that the AO erred in adopting the earlier equity valuation as the FMV for FCCDs and in treating the difference as excess premium taxable u/s 56(2)(viib) of the Act. The assessee therefore requested deletion of the addition. 5.7 However, the learned CIT(A), after relying on the ruling of the Hon'ble Supreme Court in IFCI Ltd vs Sutanu Sinha, reported in 156 taxmann.com 681 held that FCCDs are equity and accordingly confirmed the addition made by the AO. The relevant finding of the learned CIT(A) is extracted as under: 7.10 I have perused the appellant's submissions and observed that the FCCDs were issued ....
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....nal Company Law Appellate Tribunal ("NCLAT") disagreed with IFCI. In its judgment, the NCLAT reasoned that since CCDs do not contemplate repayment of the principal amount, they must be regarded as equity and not debt. To reach this holding, the NCLAT relied on the 'repayment of principal' test laid down by the Supreme Court in Narendra Kumar Maheshwari v. Union of India ("Narendra Kumar Maheshwari"). The NCLAT also relied on the Reserve Bank of India's master direction on foreign investment in India to rule against IFCI. The master direction expressly states that "debentures which are fully, compulsorily and mandatorily convertible are treated as equity instruments." IFCI filed an appeal against the NCLAT's judgment before the Supreme Court. The Supreme Court upheld the NCLAT's ruling and, in doing so, affirmed the 'repayment of principal' test laid down in Narendra Kumar Maheshwari. REPAYMENT OF PRINCIPAL' TEST In Narendra Kumar Maheshwari, the Supreme Court came up with a test to determine whether a convertible debenture would be regarded as debt or equity. The test is simple: Do the terms of the convertible debenture postulate repayment of the....
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....Projects Private Limited in (IB) No. 967 (PB), wherein it was held that where debentures have not matured for conversion, they continue to remain debt. Accordingly, it was argued that the FCCDs could not be treated as equity shares during the year and, therefore, section 56(2)(viib) of the Act was not applicable. 5.12 On valuation, the Ld. AR submitted that the AO committed an error in adopting Rs. 352.60 per share based upon an internal working prepared by the assessee for the rights issue made in June 2020. Such internal working was not a valuation report prepared by a registered valuer, as required under the relevant rules, and therefore could not be treated as the FMV for the subsequent FCCD issue. 5.13 It was submitted that the rights issue of Rs. 1.65 crore was made during the Covid-19 period, when the assessee was facing serious financial difficulty and required funds to sustain its business. In contrast, the FCCDs were issued subsequently when economic conditions had started improving. The FCCD funds were raised to complete the brewery project, support the restaurant business, and make a substantial investment in the subsidiary for the acquisition of plant and machine....
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....t as applicable to the year under consideration. The provision applies where a closely held company receives, from a resident person, any consideration "for issue of shares" which exceeds the fair market value of such shares. Thus, receipt of consideration for issue of shares is the basic jurisdictional condition for invoking the provision. The section does not use the expression "securities", "debentures", "convertible securities" or "instruments convertible into shares". Similarly, Rule 11UA of the Income Tax Rules provides the mechanism for determination of the FMV of shares and does not create any deeming fiction by which issue of FCCDs is to be regarded as issue of shares. 7.2 In our view, when a taxing provision creates a charge by specifically referring to consideration received for "issue of shares", its scope cannot be enlarged merely because another financial instrument is compulsorily convertible into shares at a future date. FCCDs may ultimately result in allotment of equity shares, but the issue of an FCCD and its subsequent conversion into an equity share are two separate events. On the date on which consideration is received against the FCCD, what is issued by the....
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.....6 In this regard, useful guidance is also available from the decision of the Mumbai Tribunal in DCIT v. Rankin Infrastructure (P.) Ltd. [2022] 142 taxmann.com 37. In that case, convertible debentures had been issued in an earlier year and were subsequently converted into preference shares. It was held that section 56(2)(viib) of the Act requires the receipt of consideration and issue of shares to occur in the manner contemplated by the provision and that conversion of debentures into shares without fresh receipt of consideration could not by itself attract section 56(2)(viib) of the Act. This reasoning reinforces the distinction between the original issue of a convertible debenture and the subsequent issue of shares upon its conversion. The relevant observation & finding of the Mumbai Tribunal is extracted as under: 10. Considered the rival submissions and material placed on record, we observe that originally assessee has issued Optionally Fully Convertible Debentures to M/s. Ranon Infrastructure Pvt. Ltd., and allotted OFCDs on 4-4-2011, 21-7-2011 and 21-3-2012. The above issue prices of the OFCDs includes share premium. During this assessment year assessee has only conv....
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....ould require us to read the words "FCCDs or other securities convertible into shares" into section 56(2)(viib) of the Act. This, in our view, is impermissible. A deeming provision which brings a capital receipt to tax has to operate within the field specifically defined by the legislature and cannot be extended to a transaction which the statutory language does not cover. 7.9 Once we hold that the issue of FCCDs during the year does not constitute an "issue of shares" for the purpose of section 56(2)(viib) of the Act, the entire exercise undertaken by the AO of comparing the FCCD issue price of Rs. 704 with the earlier equity valuation of Rs. 352.60 loses its foundation. The question whether Rs. 704 was the correct FMV under Rule 11UA, therefore, becomes academic for deciding the addition made in the year under consideration. 7.10 Nevertheless, we also find merit in the assessee's grievance regarding the manner in which the valuation was rejected. The value of Rs. 352.60 relied upon by the AO was an internal working prepared in connection with a rights issue during the Covid-19 period. On the other hand, the FCCDs were issued on the basis of a valuation report prepared by....