No Addition u/s 56(2)(vii) even if shares were purchased below FMV : ITAT
Sec 56(2)(vii) does not apply to bona fide business transactions : ITAT Mumbai
Sec 56(2)(vii) of Income Tax Act was inserted as a counter evasion mechanism to prevent money laundering of unaccounted income & does not apply to bona fide business transaction done out of business exigency. The intention of this Section was not to tax transactions carried out in the normal course of business or trade.
The object and purpose of this section, was not to strike at honest and bona fide transactions where the consideration for the transfer was correctly disclosed by the assessee but to bring within the net of taxation those transactions where the consideration in respect of the transfer was shown at a lesser figure than that actually received by the assessee, so that they do not escape the charge of tax on capital gains by understatement of the consideration. This was real object and purpose of the enactment of this section and the interpretation of this sub- section must fall in line with the advancement of that object and purpose.

No Addition u/s 56(2)(vii) even if shares were purchased below FMV : ITAT

The Extract of Order is given below for reference :
17. We further observe that provisions of section 56(2)(vii) does not apply to bonafide business transaction. As explained hereinabove, shares were issued by the company to comply with a covenant in the loan agreement with State Bank of India which required the promoters to increase the total net worth of the company to Rs. 150 crores by 31 March, 2010. Therefore, the shares were issued by the company for a bonafide reason and as a matter of business exigency. Circular No.1/2011 dated 6 April, 2011 issued by the CBDT explaining the provision of section 56(2)(vii) specifically states that the section was inserted as a counter evasion mechanism to prevent money laundering of unaccounted income. In paragraph 13.4 thereof where it is stated that “the intention was not to tax transactions carried out in the normal course of business or trade, the profit of which are taxable under the specific head of income”.
18. In the instant case, the transaction of issue of shares was carried out to comply with a covenant in the loan agreement with the bank to fund the acquisition of the business by the subsidiary in USA, therefore, such a bonafide business transaction cannot be taxed under section 56(2)(vii) of the Act especially when there is not even a whisper about money laundering by the AO in the assessment order. Further, we observe that the consideration for the shares was received through banking channel. This object behind introduction of section 56(2)(vii) should be borne in mind. In this regard, reliance may be placed on the Judgment of Supreme Court in the case of ITO vs. K P Varghese (131ITR 597) wherein the Apex Court at Page 609 in the context of section 52(2) of the Act held as under:

“The object and purpose of sub-section (2), as explicated from the speech of the Finance Minister, was not to strike at honest and bona fide transactions where the consideration for the transfer was correctly disclosed by the assessee but to bring within the net of taxation those transactions where the consideration in respect of the transfer was shown at a lesser figure than that actually received by the assessee, so that they do not escape the charge of tax on capital gains by understatement of the consideration. This was real object and purpose of the enactment of sub-section (2) and the interpretation of this sub- section must fall in line with the advancement of that object and purpose. We must, therefore, accept as the underlying assumption of sub-section (2) that there is understatement of consideration in respect of the transfer and sub-section (2) applies only where the actual consideration received by the assessee is not disclosed and the consideration declared in respect of the transfer is shown at a lesser figure than that actually received.”

19. In view of the above, the provisions of section 56(2)(vii)cannot be applied to transaction under consideration.
20. Moreover, the provisions of section 56(2)(vii) are applicable only from 1st October, 2009. In the instant case, the offer was made by the company to the shareholders to subscribe for the shares on 7 September, 2009 pursuant to resolution passed by board of directors on the same date. Further, on 21st September, 2009, the company informed the shareholders about the acceptance of shares offered by the company. Therefore, the offer made by the company was accepted by the shareholders before 1st October, 2009 hence, the contract between the company and the shareholder for issue by the company of shares was completed before 1st October, 2009. Accordingly, the provisions of section 56(2)(vii) do not apply to as the contract was executed prior to 1st October 2009. It was only the formal routine act of issuance of the share certificate by the company which took place after 1 October, 2009. The revenue has also relied on the provisions of section 17 that there would be a tax liability under section 17, even if section 56(2)(vii) does not apply, as the assessee being an employee of the company. The allotment of shares by the company the holding of the assessee came down from 34.57% to 33.30%, i.e., shareholding of the assessee witnesses a decline after the shares were allotted by the company, no benefit was received by the assessee and therefore, even the provisions of section 17 of the Act are not applicable.
21. Furthermore, the provisions of section 17 do not apply to the shares allotted by the company to the assessee as the shares were not allotted by the company to the assessee in his capacity of being an employee of the company. The shares were offered and allotted to the assessee by the company by virtue of the assessee being a shareholder of the company. Therefore the provisions of section 17 are not applicable. Circular No. 710 dated 24 July, 1995 also supports the assessee’s stand that where shares are offered by company to a shareholder, who happens to be an employee of the company (as Mr. Subodh Menon indeed is), at the same price as have been offered to other shareholders or the general public, there will be no perquisite in the shareholder’s hands. In the instant case, the shares were offered to the assessee and other shareholders at a uniform rate of Rs. 100 and therefore, the difference between the fair market value and issue price cannot be brought to tax as a perquisite under section 17 of the Act.
22. In view of the above, we do not find any infirmity in the order of CIT(A).
23. In the result appeal of the Revenue in ITA No.676/Mum/2015 is dismissed.
ITA No.2776/Mum/2015 (A.Y.2010-11)
24. Facts and circumstances in the case of P.N.Ramaswamy in ITA No.2776/Mum/2015 are same as discussed hereinabove, following the reasoning given hereinabove, we do not find any reason to interfere in the order of CIT(A).
25. In the result appeal of the Revenue in ITA No.2776/Mum/2015 is dismissed.
26. In the result both the appeals filed by Revenue are dismissed.
Order pronounced in the open court on this 07/12/2018
Click here to read Order of Mumbai ITAT