No addition u/s 56(2)(viib) when no money/ consideration was received – HC

No addition u/s 56(2)(viib) when no money/consideration was received by assessee on issue of shares which were allotted merely on account of conversion of outstanding loans

In a recent judgment, Hon’ble High Court of Himanchal Pradesh has held that no addition can be made u/s 56(2)(viib) when no money/consideration was received by assessee on allotment of shares merely on account of conversion of outstanding loans.

ABCAUS Case Law Citation:
ABCAUS 4169 (2024) (07) HC

In the instant case, the Income Tax Department (ITD) had challenged the order passed by the Income Tax Appellate Tribunal (Tribunal) in holding in that there was no case of application of Section 56(2)(viib) of the Income Tax Act, 1961 (the Act) where pre-existing unsecured loans of partners/shareholders were converted into equity shares at premium.

The respondent-assessee is engaged in the business of Generation and Distribution of Hydro Electricity in the State of Himachal Pradesh. For the Assessment Year in question, it filed return of income declaring loss.

During the year, the assessee had issued 2.25 crores equity shares with face value of Rs.10/- per share for a premium of Rs. 90/- per share. The assessee-company was having opening balance of unsecured loans which were converted into share capital as per the agreement.

The case of the assessee was selected for Limited Scrutiny under the e- Assessment Scheme In its reply to the Notices issued u/s 143 of the Act, the assessee stated that prior to allotment both the share subscribers were partners in the assessee-firm and the balances were showing as Partners Capital Account. It was further submitted that the shares had been valued as per Discounted Cash Flow (DCF) Method, prescribed in Rule 11UA of the Income Tax Rules and a Certificate was also obtained from the Chartered Accountant, as required under the Income Tax Rules.

The valuation report furnished by the assessee-company was rejected by the Assessing Officer (AO), holding that the DCF valuation used by the assessee, was bogus and had no connection with the real figures. The assessment order stated that the valuation was done with fictitious figures having no correlation with actual affairs of the assessee-company. Thereafter, the Assessing Officer, National Faceless Assessment Centre, computed the fair market value of the unquoted shares on the basis of balance sheet figures as per NAV method and passed his order.

The assessment was completed by the Assessing Office (Faceless) u/s 143(3) read with Section 143(3A) & 143(3B) of Act by making an addition of Rs. 202.50 crores under the Head ‘Income from Other Sources’ under Section 56(viib) of the Act, on account of excess amount per share paid as premium.

The CIT(Appeals) deleted the additions made by the Assessing Officer holding that since no money/consideration was received by the assessee on issue of shares and the shares were allotted merely on account of conversion of outstanding loans received in earlier years and source whereof was accepted to be satisfactorily explained into share capital, Section 56(2)(viib) of the Act in absence of receipt of consideration, was not applicable.

The CIT(A) also held that the valuation is done by the assessee as per DCF method, which is an internationally accepted method of valuation of shares, and is a permissible methodology as per Rule 11UA(2)(d) of the Rules. That the right to select the method of valuation (NAV or DCF), is vested with the assessee, and the Assessing Officer erred in substituting the assessee’s method of valuation, i.e. DCF, with his own method of valuation, i.e. NAV method, and had acted completely beyond his jurisdiction. It was also held that the report of the Technical Expert is binding on the Assessing Officer, which cannot be disregarded/rejected without any cogent reasons.

The Tribunal confirmed the finding of fact that the assessee did not receive any consideration for allotment of shares in the previous year relevant to the current assessment year, and upheld the view of the CIT (Appeal) if no consideration was received in the previous year under consideration, Section 56(2)(viib) of the Act has no application.

The Tribunal further held that the consideration in the form of unsecured loans were received from the partner of the erstwhile firm, as evidenced from loan agreement, and the Assessing Officer could not bring out any material facts to show that such conversion of loans to equity shares was a ploy to defraud revenue of the tax on such transaction.

The Tribunal went further and observed that the Assessing Officer is not authorized to pick and choose a particular method of valuation of shares, since the option in that regard is specifically given only to the assessee as per Rule 11UA(2) of Income Tax Rules and the AO can only verify method of valuation adopted by the assessee, but the same cannot be substituted by the AO.

The Hon’ble High Court observed that he orders passed by the Tribunal and the CIT(Appeals) were fairly comprehensive. Both of them concurrently found that no consideration was received by the assessee-firm for allotment of the shares, therefore Section 56(2)(viib) of the Act would not apply, and that it would have applied only if consideration was received for such a transaction. Also, both the Tribunal and the CIT(Appeals) had held that the Assessing Officer had no jurisdiction to substitute the NAV method of assessing the valuation of shares, once the assessee had exercised option of a DCF valuation method as per Rule 11UA(2) of the Income Tax Rules.

The Hon’ble High Court expressed agreement with the reasoning adopted by the CIT(Appeals) confirmed by the ITAT on all aspects and held that no substantial questions of law arise in this appeal for consideration.

Accordingly, the appeal of the Revenue was dismissed. 

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