In what could benefit many start-ups in the country, the Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has ruled that premium earned on allotment of preference shares by a loss-making entity cannot be taxed.
The tribunal said the valuation of shares is not relevant for determining the genuineness of the transaction. The ruling, pertaining to Section 68 of the Income Tax Act, stated that the assessing officer (AO) can only verify the nature and source and not question the genuineness of the premium on allotment of preference shares.
Piramal Realty case
Under Section 68 of the IT Act, if a closely-held company issues share capital but is unable to justify the source of income of the shareholder, then the AO can treat the amount received on such issuance as income of the company, which will then attract income tax.
The ruling comes in an appeal by the revenue authorities against the order of the Commission of Income Tax (Appeals) in a case related to Piramal Realty for the financial years 2010-11 and 2011-12.
The real estate company had issued 59,850 cumulative compulsory convertible preferential shares (CCPSs) of ₹10 each to Piramal Estates Private Ltd (PEPL) for ₹5.98 lakh and also charged share premium for the same at ₹99,990 resulting in a total of ₹598.44 crore. The Revenue Department contended that the company had a negative net worth and suffered losses during assessment years 2011-12 and 2012-13 and the premium on CCPSs of ₹1 lakh was without any basis and the nature and source of credit were not proved.
“...valuation is not relevant for determining the genuineness of the transaction for the purpose of Section 68 of the Act,” the Tribunal held while ruling in favour of Piramal Realty. The company had disclosed the transaction in its books of accounts, filing statutory forms and providing name, address and PAN of the shareholder.
Tax authorities have in the past questioned the valuation premium of start-ups and the Ministry of Corporate Affairs is also understood to be looking into the issue.
“It was held that Section 68 can be invoked only if there is a doubt on the source of income of the shareholders. There was no doubt on the creditworthiness of shareholders in this case and the addition by the AO was deleted,” said Amit Agarwal, Partner, Nangia Advisors.
However, tax experts said the AO could still tax premium on preference shares using Section 56(2)(viib), which was introduced in 2013-14.
Amit Maheshwari, Partner, Ashok Maheshwary & Associates, said when the issue price is more than the fair market value of shares, the excess shall be considered as the income of the company issuing such shares.