Share premium received on issue of shares is not taxable under the Incometax

Transcription

1 KPMG FLASH NEWS KPMG IN INDIA Share premium received on issue of shares is not taxable under the Incometax Act 6 September August 2013 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Green Infra Ltd. 1 (the taxpayer) had an occasion to deal with taxability of premium received on issue of shares. The Tribunal held that share premium realised from the issue of shares is capital in nature and forms part of the share capital of the company and therefore cannot be taxed as revenue receipt. The Tribunal also held that it is a prerogative of the Board of Directors of a company to decide the premium amount and it is the wisdom of the shareholders whether they want to subscribe to shares at premium. As per news reports, the tax officer based on transfer pricing officer s order imputed share premium in the case of Shell India and, inter alia held the alleged premium receivable as income chargeable to tax. However, the Shell India has contended that money received/receivable on account of issuance of share capital, including share premium being capital receipt is not chargeable as income under the Income-tax Act, 1961 (the Act). Shell India has filed a writ petition before the Bombay High Court against the order of the tax officer and the High Court s decision is awaited. 1 Green Infra Ltd. v. ITO (ITA No.7762/Mum/2012) Taxsutra.com As per news reports, some of the grounds raised by Shell before the Bombay High Court are as follows: The transaction of subscription to share capital is distinct and different from trading in goods and services. Capital receipts are not taxable, unless there is specific provision of chargeability. As per the provision of Section 78 of the Companies Act, 1956, a company is debarred from freely using the proceeds of share premium, except for specified purposes. The Bombay High Court in the case of Cadell Weaving Mills Company Ltd 2 held that capital receipt is not income under Section 2(24) of the Act, unless it is chargeable to tax as capital gains under Section 45 of the Act. Further the Bombay High Court in the case of Mahindra & Mahindra Ltd. 3 held that receipt is not taxable when it is on account of fixed capital. 2 Cadell Weaving Mills Company Ltd. [2001] 249 ITR 265 (Bom) 3 Mahindra and Mahindra Ltd [1973] 91 ITR 130 (Bom)

2 It is important to note that the Finance Act, 2013 has introduced a new set of provisions under Section 56 of the Act. It provides that where a company, not being a company in which the public are substantially interested, receives from resident of India consideration for issue of shares that exceeds the face value of such shares then such consideration shall be chargeable to tax as income from other sources. These provisions come into effect from 1 April 2013 (AY ). The above-referred amendment applies only to a private company (viz. not being a company in which the public are substantially interested). Therefore, the Mumbai Tribunal decision in the case of Green Infra Ltd. and the ratio laid down therein with respect to treatment of share premium can be helpful to the companies in which the public are substantially interested. Further this decision can also be helpful to cases such as Shell India and similar cases where the tax department seeks to tax share premium as revenue receipt. The Tribunal s ruling is summarised in following annexure: Annexure Facts of the case The taxpayer has a paid up share capital of INR 0.5 million and there was no reserves and surplus available with the taxpayer as on that date. During the year under consideration, the taxpayer received an amount of INR million on the issue of equity shares to the shareholders which was credited to share premium account. The allotment of shares of face value of INR 10 each at a premium of INR 490 per share. IDFC Private Equity Fund-II, SEBI registered venture capital fund, was holding 98 percent shares in the taxpayer. Further, the Government of India is holding 18 percent of shares of IDFC Private Equity Fund-II. The taxpayer had set up three subsidiaries and invested funds in these three subsidiaries which have been floated as Special purpose Vehicle for generating Wind energy. The taxpayer claimed that the issuance of shares at premium was a commercial decision which does not require any justification under any law. The subscribers to the Memorandum of Association have subscribed the shares and these shares were allotted at par and all the remaining shares were allotted at a premium. The Assessing Officer (AO) observed that the share premium collected is not utilised for the purpose and objectives and the same was collected without following the conditions specified under the Companies Act, It is a colourable devices used for the purpose of tax evasion and therefore the AO held that share premium is taxable under Section 56(1) of the Act. The AO also disallowed the expenditure claimed by the taxpayer and also the depreciation on the ground that it has not commenced its business and expenditure is of capital in nature. The Commissioner of Income-tax (Appeals) [CIT(A)] upheld the order of the AO. Issues before the Tribunal Whether share premium collected by the taxpayer is a colorable devices used for the purpose of tax evasion? Whether such premium is taxable under Section 56 of the Act? Whether expenditure claimed by the taxpayer while computing its taxable income is of capital in nature? Taxpayer s contentions All the directors have received an internal report on valuation of shares and the valuation has been done on discounted cash flow method. Further, the share premium has been decided by the board of directors and there is no prohibition under the Companies Act, 1956 so far as the amount of premium is concerned. Relying on the CBDT Notification 4 it was contended that CBDT has approved vide this notification that the fair market value of the unquoted equity shares determined by a merchant banker or an accountant can be as per the discounted free cash flow method. Relying on the decision of the Supreme Court in the case of Allahabad Bank Ltd 5 it was contended that, being a capital receipt, the share premium cannot be taxed as a revenue receipt under Section 56(1) of the Act. The taxpayer relied on the Supreme Court in the case of Standard Vaccum Oil Co 6 and on various decisions 7 where it has been held that premium realised from the issue of its shares represents reserves not allowed in computing the profits of the company for the purpose of the Act. The shareholders are under direct control of the Government of India as it was holding 18 percent of shares in IDFC Private Equity Fund - 2. Therefore, it cannot be said that the transactions are bogus/sham. Within three months from the end of the year one, the subsidiary of the taxpayer has started generating electricity as is evidenced from the certificates issued by the Tamil Nadu Electricity Board. The AO has wrongly concluded that IDFC is a mutual fund company whereas the same is a venture capital fund registered with SEBI. 4 CBDT Notification 52, dated 29 November CIT v. Allahabad Bank Ltd [1969] 73 ITR 745 (SC) 6 CIT v. Standard Vaccum Oil Co. [1966] 59 ITR 685 (SC) 7 ACIT v. Om Oils and Oil Seeds Ltd. [1985] 152 ITR 552 (Del) CIT v. Krishnaram Baldeo Bank (P) Ltd. [1983] 144 ITR 600 (MP)

3 Tax department s contentions The pre-requisite for the issue of shares at premium is substantial increase in the net worth of the company. It is mainly the profitability, credibility, goodwill of the concern which creates the opportunity and requirement of premium. However, in the present case the taxpayer fails to satisfy these requirements. The premium attached to the shares has not been received from the open market. It is a limited group transaction and is not entered with open and general subscribers who could pay the premium. The shares do not have intrinsic value to give price to premium in the industrial, normal and actual worth of the company. The receipt of premium on shares is a windfall receipt since the net worth of the company is nonexistent. There was no corresponding accretion to the assets of the company which could justify the premium received on the shares. There is no material basis which could justify substance of the transaction and also in law. In order to support its contentions the tax department relied on various decisions 8. In the case of Sreelekha Banerjee & Others 9 the Supreme Court has held that if explanation is unconvincing and one which deserves to be rejected, the tax department can reject and draw the inference that the amount represents income either from the source already disclosed by the assessee or from some undisclosed source. Tribunal s ruling It is a prerogative of the Board of Directors of a company to decide the premium amount and it is the wisdom of the shareholders whether they want to subscribe to such a heavy premium. The tax department cannot question the charging of such of huge premium without any bar from any legislated law of the land. The Board of Directors contains persons who are associated with IDFC group in which government has a shareholding and therefore their integrity and credibility cannot be doubted. On perusal of Section 56(1) of the Act it indicates that to tax any amount under this section, it must have some character of income. It is a settled proposition of law that capital receipts, unless specifically taxed under any provisions of the Act, are excluded from income. Share premium realised from the issue of shares is of capital in nature and forms part of the share capital of the company and therefore cannot be taxed as a Revenue receipt. 8 CIT v. Durga Prasad More [1971] 82 ITR 540 (SC), Sumati Dayal v. CIT [1995] 214 ITR 801 (SC) 9 Sreelekha Banerjee & Others v. CIT [1963] 49 ITR 112 (SC) It is also a settled proposition of law that any expenditure incurred for the expansion of the capital base of a company is to be treated as a capital expenditure as has been held by the Supreme Court in the case of Punjab State Industrial Corporation Ltd 10 and in the case of Brooke Bond India Ltd 11. Thus the expenditure and the receipts directly relating to the share capital of a company are of capital in nature and therefore, cannot be taxed under Section 56(1) of the Act. The subscribers to the share capital are all companies. The confirmations of the transactions have been received by the AO and therefore, identity has been established beyond all reasonable doubts. Further, the tax department did not question the identity of the share holders. The transaction is genuine since the entire transaction has been done through the banking channels duly recorded in the books of accounts duly reflected in the financial statement of the taxpayer. The taxpayer has invested funds in its three subsidiary companies wherein the taxpayer is holding percent of share capital which means that the funds have not been diverted to an outsider. Since the taxpayer itself is holding percent of shares and in turn the taxpayer s 98 percent of shares are held by IDFC Private Equity Fund-II, this entire shareholding structure cannot be said to generate any transaction which could be said to be sham. Accordingly, share premium could not be treated as income of the taxpayer under Section 56(1) of the Act. The Tribunal observed that registrar of companies have issued certificate of commencement of business. The details of all the expenses have been furnished before the AO which were incurred for setting up of the subsidiary companies. A perusal of the main objects of the company indicates that one of the main objects of the company is that of financing, investing, sourcing, operating, green or clean technology products and services that optimises the use of natural resource or reduces the negative environmental impact of infrastructure projects and/or related assets. 10 Punjab State Industrial Corporation Ltd v. CIT [1997] 225 ITR 792 (SC) 11 Brooke Bond India Ltd v. CIT [1997] 225 ITR 798 (SC)

4 Considering these main objects of the taxpayer, it has been held that the taxpayer has set up three subsidiary private limited companies and one of these subsidiaries has started generating electricity as per the certificates given by the Tamil Nadu State Electricity Board. Considering all these facts in totality, it has been held that the taxpayer has commenced its business and therefore is eligible for all the legitimate expenses including depreciation.

5 Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad Tel: Fax: Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore Tel: Fax: Hyderabad /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Tel: Fax: Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi Tel: Fax: Chandigarh SCO (Ist Floor) Sector 8C, Madhya Marg Chandigarh Tel: /781 Fax: Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai Tel: Fax: Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana Tel: Fax: Kolkata Infinity Benchmark, Plot No. G-1 10th Floor, Block EP & GP, Sector V Salt Lake City, Kolkata Tel: Fax: Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai Tel: Fax: Pune 703, Godrej Castlemaine Bund Garden Pune Tel: Fax: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG, an an Indian Partnership and and a a member firm firm of of the the KPMG network of of independent member firms firms affiliated with with KPMG International Cooperative ( KPMG ( KPMG International ), International ), a a Swiss Swiss entity. entity. All All rights rights reserved. reserved. The KPMG name, logo and cutting through complexity are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.