Allotment of shares of a new corporate body cannot be taxed under the head “income from other sources”

The Mumbai Income Tax Appellate Tribunal held in a recent judgment that the allotment of shares at premium by a newly incorporated company should not be treated as income as per the provisions of section 56(1) of the Income Tax Act.

The Tribunal in the case of Green Infra Ltd. v. ITO [TS-420-ITAT-2013(Mum)] held that if the authenticity and identity of the depositor is proved and it is established that the transaction was conducted by banking channels, the transaction cannot be treated as a sham transaction and the premium cannot be taxed as per section 68 of the Income Tax Act.

Brief facts of the case:

The assessee was incorporated on 3.4.2008 and regularly assessed for the Financial Year 2008 – 09. Out of the total investment amounting to 489.5 million, the Assessing Officer observed that 479.7 million was received in the form of share premium on the allotment of shares.

The assessee filed a valuation report by adopting the means of the discounted cash flow method and other relevant documents regarding the determination of valuation of the shares obtained before issuing of the shares.

The Assessing Officer had the view that as the company had paid-up capital of 0.50 million on incorporation, the valuation of shares was not justified.

Moreover, the Assessing Officer raised question regarding the application of funds collected through share premium invested in shares of other companies which was considered as violation of Section 78 of the Companies Act, 1956.

The Assessing Officer held that the share premium received should be taxed under the head “income from other sources” as per section 56(1) of the Income Tax Act.

The Commissioner of Income Tax (Appeals) confirmed the order passed by the Assessing Officer, stating that the assessee failed to prove the authenticity of the share premium received and that section 56(1) of the Act covers all cases not coming under sections 4 and 5 of the Income Tax Act.

Arguments made by the Revenue:

The Revenue contended that there was no data to prove the estimates of the assessee for preparation of the valuation report. The actual values were not same as those which were projected for valuation report. The assessee relied upon a report made by following the DCF method, which was not at all realistic and was done without any supporting evidence.

It was further argued that the assessee did not have any asset like intellectual property rights or any investment commanding a premium during allotment of new shares.

The assessee failed to use the share premium received; as such the transaction was not a capital receipt and was a residuary receipt which was taxable as per Section 56(1) of the Act.

The Assessing Officer cited the decision passed by the in Supreme Court in McDowell and Co, Ltd. The Revenue also relied on the decisions of High Courts in the cases of Ramdeo Samadhi.

An additional contention was raised regarding taxing the premium as sham, as the nature of transaction was already questioned by the Revenue to prove that taxability is not dependent upon accounting system of the assessee.

Arguments made by the Assessee:

The assessee argued that issuing shares was a commercial act and did not require justification under any prevailing law. It was further argued that the premium was a capital receipt which should be considered under the provisions of section 78 of the Companies Act as share premium is a capital receipt.

The assessee cited the decision passed by the Supreme Court in the case of Commercial Tax Officer (1985) 154 ITR 148 (SC), where it was stated that share premium should be included in the paid up capital account no matter whether it is been maintained in a separate account or not.

Moreover, the assessee cited the Supreme Court decision in Standard Vaccum Oil Co. where it was held that premium collected by means of issue of shares denoted reserve not included in computing the profits of the company for the purpose of tax laws. The decision passed by the High Court in Om Oils & Seeds Exchange Ltd. was also referred.

The Central Board of Direct Taxes (CBDT) held that share premium was not a revenue receipt. The shareholders were under the direct control of the Government of India; as such the transaction cannot be called sham. The Board of Directors of a company should decide the premium amount and the shareholders should decide whether they desire to subscribe at such a premium or not.

In the absence of law putting any restriction, the revenue should not raise any question regarding the charging of premium.  Any receipt can be taxed as per section 56(1) of the Act only if it is an income.

It was contended that the revenue’s logic that share premium was not used for which it was received was not correct.

The Tribunal relied on the decisions of Apex Court passed in the case of Punjab State Industrial Corporation Ltd. where the Tribunal held that share premium is a capital. The shareholders are related to the Government and their identity had been established beyond any doubt.

The identity of the shareholders had not been questioned. The entire transaction was conducted through banking channels; as such section 68 of the Act was not applicable.

The judgment:

It was held that the premium paid for shares of a new incorporated company cannot be taxed as income.  Moreover, where the authenticity of the shareholders was established, it cannot be declared as a sham transaction.