AO if not satisfied must compute FMV 56(2)(viia) Rule 115UA himself

Where a method has been prescribed by the legislature, that method alone shall be followed for computation of the fair market value

INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCHES “A” : HYDERABAD

ITA.No.871/Hyd/2015 Assessment Year 2011-2012

M/s. Medplus Health Services P. Ltd (Appellant)  vs.  Income Tax Officer (Respondent)

Date of Order: 08/03/2016

ORDER

PER SMT. P. MADHAVI DEVI, J.M.

This is assessee’s appeal for the A.Y. 2011-12. The assessee has raised the following grounds of appeal.

1. “On the facts and the circumstances of the case and in law, the assessment made is very highly excessive and contrary to facts, law and principles of natural justice and fair play.

2. On the facts and the circumstances of the case and in law, the Hon’ble Commissioner of Income Tax (Appeals)-4 [‘CIT(A)’] erred in upholding the assessment order of the Income Tax officer, Ward 16(1) (Learned AO) in the name of Medplus Health Care P. Ltd., which is not in existence on the date of passing the order and serving the said order on the appellant.

3. On the facts and the circumstances of the case and in law, the Hon’ble CIT(A) erred in upholding the order of the Learned AO of making an addition of Rs. 21,22,73,565 to the appellant’s income as deemed gift u/s. Section 56(2)(viia) of the Act without appreciating the fact that the FMV of shares on transaction date was negative and hence, question of any addition u/s. 56(2)(viia) of the Act does not arise.

4. On the facts and the circumstances of the case and in law, the Hon’ble CIT(A) erred in upholding the order of the Learned AO of making an addition of Rs.21,22,73,565 to the appellant’s income as deemed gift u/s. Section 56(2)(viia) of the Act without appreciating the submissions filed by the appellant on non-applicability of Section 56(2)(viia) of the Act in the appellants case.

5. On the facts and the circumstances of the case and in law, the Hon’ble CIT(A) erred in upholding the action of the AO in not following the prescribed Rule-11UA while computing disallowance u/s 56(2)(viia) of the Act. The appellant prays that the aforesaid addition made by the A.O. be deleted.

6. On the facts and in circumstances of the case, the Ld AO erred in levying interest under section 234C of the Act.

7. On the facts and in circumstances of the case, the Ld AO erred in initiating penalty proceedings under section 271(1)(c) of the Act.” The above grounds of appeal are without prejudice to each other.”

1.1. The assessee has also raised the following additional ground of appeal along with an application for admission of the same.

“On the facts and in the circumstances of the case and in law :

8. Without prejudice to Ground No. 3-5, the learned Income Tax Officer, Ward 16(1) (learned ‘AO’) erred in computing the addition under section 56(2)(viia) with respect to 15,90,000 partly paid shares amounting to Rs.10,33,34,100.”

2. Brief facts of the case are as follows:

The assessee is a company engaged in the business of whole sale trading of pharmaceuticals, medicines, general stores and its related items and running of clinics. Its supply of goods is mainly to its group company M/s Optival Health Solutions Private Ltd which is engaged in retail business of pharmaceuticals and general goods. The assessee company filed its return of income on 30.09.2011 declaring income at ‘NIL’ after set off of brought forward loss of Rs.72,76,000 under normal provisions of the Act and book profit under section 115JB of the Act also at Rs. NIL. The same was initially processed u/s. 143(1) of the I.T. Act. Meanwhile, there was a survey operation under section 133A of the Act on the assessee on 01.07.2011, during the course of which, certain facts were observed. Thereafter, the case was selected for scrutiny under CASS and assessment proceedings under section 143(3) were initiated by issuance of notices u/s 143(2) and 142(1) of the Act. In response, the assessee submitted the required details before the AO.

3. During the assessment proceedings u/s 143(3) of the Act, AO observed that the assessee company is a wholesale supplier of goods mainly to its group company M/s. Optival Health Solutions P. Ltd., which in turn is engaged in retail business of pharmaceuticals and general goods and further that both the companies have more than 67% common shareholdings. It was observed that during the F.Y. 2010-11, a major restructuring of the group had taken place wherein almost all the shares of M/s. Optival Health Solutions P. Ltd., were taken-over by the assessee company and the wholesale operations from the assessee were taken-over by M/s. Optival Health Solutions P. Ltd., resulting in the assessee company becoming the holding company of M/s. Optival Health Solutions P. Ltd., and both the wholesale and retail operations coming under the assessee company indirectly. He further observed that majority of the small shareholders of M/s. Medplus Health Care P. Ltd., transferred their shares to Mr. G. Madhukar Reddy, promoter and one of the major shareholders of assessee company and Mr. Madhukar Reddy along with other major shareholders transferred their majority of share holdings at an attractive price to some local and international institutional investors. Out of these transactions, the A.O. observed that two persons i.e., Mr. C. Srinivasa Raju and Chintalapati Holdings P. Ltd., transferred their shares to the assessee on 04.03.2011 at Rs.75.49 per share whereas, on the same day and also on 08.03.2011 all the other shareholders transferred their shareholdings to the assessee at Re.1 per share. He observed that when the market rate is Rs.75.49ps, the assessee has purchased the shares at less than the market price i.e., Rs.1 per share and therefore, the transactions attract provisions of section 56(2)(viia) of the I.T. Act. Therefore, the A.O. issued a show cause notice dated 27.02.2014 requiring the assessee to explain as to why the difference amount of Rs.74 per share should not be treated as a deemed gift/income and taxed in the hands of the company. The assessee, vide letter dated 07.03.2014, submitted a detailed note as to why the provisions of section 56(2) (viia) are not applicable to the assessee’s case. It was submitted that as per Explanation to Section 56(2)(viia) of the Act, the ‘fair market value’ (FMV in short) has to be computed in accordance with Rule 11UA of I.T. Rules and that the assessee had computed the fair market value as per the prescribed rule according to which, the fair market value of the share is less than Rs. zero and hence, payment of Rs.1 per share by the assessee to acquire the shares is more than the fair market value computed under Rule 11UA. Thus, according to him, the provisions of section 56(2)(viia) of the Act do not apply. The A.O. however, was not convinced with the assessee’s contentions and held that the ‘market value’ mentioned in the rule means “price which it would have fetched if sold in the open market.”

He observed that the valuation of any property is based on the fact as to what value the property would fetch if sold in the open market and since in the assessee’s own case there are certain transactions to clearly establish market value of the shares sold, resorting to estimation/calculation of market value of the unlisted shares as per the formula under Rule 11UA of I.T. Rules does not arise. He observed that as per the computation of fair market value under Rule 11UA(c)(b) of I.T. Rules, the value of M/s. Optival Health Solutions P. Ltd., was (-) Rs.64.48ps (i.e., the value of M/s. Optival share is at negative figure) whereas, assessee has paid Rs.1 per share and the basis for adopting Rs.1 per share by the assessee is not provided. He further observed that one of the shareholders Mr. Kalyana Bhaskara sold his shares in Optival to Mr. Madhukar Reddy at Rs.63.79ps per share and the basis for adopting this rate is also not known but since it was much more than what is claimed by the assessee at Rs.1 per share, he held that it was so shown to defraud the Revenue by transacting at abnormally low price. He therefore, held that the provision of deemed gift under section 56(2)(viia) of the I.T. Act is applicable. Thus, he adopted the price of Rs.75.49ps paid to unrelated parties to be the market price of the unquoted shares of the company M/s. Optival Health Solutions P. Ltd., and the difference of Rs.74.49ps per share was treated as “Income from other sources” in the hands of the company. Further, vide its letter dated 19.03.2014, the assessee submitted that as on 3rd March, 2011, the total value of equity shares of M/s. Optival Health Solutions P. Ltd., was Rs.45,44,740, out of which, the shares of Rs.15,90,000 were partly paid i.e., only up to Rs.0.50ps and that these partly paid up shares were also acquired by the company from the shareholders. It was submitted that in the case of partly paid up shares, an amount of Rs.9.50ps is still to be paid by the purchaser and hence, the value of deemed gift in the case of partly paid shares is to be calculated accordingly. After considering the assessee’s contentions, the A.O. computed the value of the deemed gift of partly paid up shares at Rs.10,33,34,100 and of fully paid up shares at Rs.10,89,39,465 and brought it to tax. Aggrieved, assessee preferred an appeal before the Ld. CIT(A) who confirmed the order of the A.O. and against the order of the Ld. CIT(A), the assessee is in second appeal before us.

4. The Ld. Counsel for the assessee, Mr. Kanchan Kaushal, while reiterating the submissions made by the assessee before the authorities below, drew our attention to the provisions of section 56(2)(viia) of the I.T. Act, to demonstrate that the said provisions would apply to the assessee only if the price paid by the assessee was less than the fair market value computed under Rule 11UA of I.T. Rules. He submitted that where the legislature prescribes a particular method to be adopted, then the said method alone should be adopted. He has submitted that in the case of assessee before us, neither the provisions of section 56(2)(viia) nor the Rules prescribe for adoption of the market value of the shares as the fair market value for the purpose of deemed gift under section 56(2)(viia) of the I.T. Act since the provisions relates to anti abuse provisions. He submitted that where a specific method is prescribed, the A.O. is precluded from adopting any other method. He further drew our attention to the decision of Hon’ble Allahabad High Court in the case of Dr. Shashi Kant Garg vs. CIT & Ors. reported in (2006) 285 ITR 158 in support of his contention that a prescribed method has to be strictly followed. He has also placed reliance upon the following other judgments in support of his contention :

(i) M/s. Morarji Textiles Ltd., ITA.No.1979/Mum/2009 dated 10.05.2014

(ii) Bharat Hari Singhania & Others vs. Commissioner of Wealth Tax & Others. (1994) 207 ITR 1 (SC)

(iii) Mrs. Prem Shamsher Singh vs. Commissioner of Wealth Tax (1994) 210 ITR 233 (Del.HC)

(iv) Chandra Kishore Jha vs. Mahavir Prasad & Ors. (1999) 8 SCC 266 (SC) (v) State of Uttar Pradesh vs. Singhara Singh & Ors. 1963 AIR 358 (SC)

(vi) Danish Aarthi vs. M. Abdul Kapoor CRP (NPD) (MD) No.475 & 476 of 2004 (Mad. HC)

5. The Ld. D.R. on the other hand, supported the orders of the authorities below and submitted that where the market price of the shares at which the assessee has purchased the shares on the very same day is available, the A.O. has rightly adopted the same instead of resorting to the valuation of the fair market value of the shares under Rule 11UA of the I.T. Act. Thus, according to him, the assessment order is to be upheld.

6. Having regard to the rival contentions and the material on record, we find that ground No.1 is general in nature and hence needs no adjudication. With regard to ground No.2, we find that though the assessee has raised this ground of appeal before the Ld. CIT(A), it was rejected on the ground that the assessee did not press the said ground of appeal. Even before us, the assessee did not advance any arguments on this issue at the time of hearing. In view of the same, ground No.2 of the assessee is not adjudicated and treated as rejected.

7. As regards grounds No. 3 to 5 are concerned, we find that the undisputed facts are that the assessee has purchased the shares of M/s. Optival Health Solutions P. Ltd., at Re.1 on 4/3/2011 and 8/3/2011 while some of the share holders have sold the shares of the very same company to the assessee on the very same day at Rs.75.49 per share. It is also not disputed that the assessee company and M/s. Optival Health Solutions P. Ltd., are related to each other. The only dispute is whether the provisions of section 56(2)(viia) of the I.T. Act are applicable to the facts of the case before us. For the sake of convenience and ready reference, the relevant provisions are reproduced hereunder :

56. (1) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income tax under the head “income from other sources” if it is not chargeable to income tax under any of the heads specified in Section 14, items A to E .

(2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the followings incomes, shall be chargeable to income tax under the head “income from other sources” namely,

(i)………….

(viia) where a firm or a company not being a company in which the public are substantially interested, receives, in any previous year, from any person or persons, on or after the 1st day of June, 2010, any property, being shares of a company not being a company in which the public are substantially interested,—

(i) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property ;

(ii) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration :

Provided that this clause shall not apply to any such property received by way of a transaction not regarded as transfer under clause (via) or clause (vic) or clause (vicb) or clause (vid) or clause (vii) of section 47.

Explanation.—For the purposes of this clause, “fair market value” of a property, being shares of a company not being a company in which the public are substantially interested, shall have the meaning assigned to it in the Explanation to clause (vii);]”

7.1. Further, the Explanation to clause (vii) to 56(2) of the Act reads as under :

EXPLANATION:

(b) “fair market value” of a property other than an immovable property, means the value determined in accordance with the method as may be prescribed.”

7.2. The prescribed method for valuation of the fair market value is under Rules 11U and 11UA(c)(b) of I.T. Rules. Rule 11UA (c)(b) reads as under :

“Rule 11UA(c)(b) as inserted by IT (Second Amdt.) Rules, 2010, applicable w.r.e.f. 1.10.2009 i.e., applicable for transactions undertaken after 1st October, 2009.

(b) the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner, namely :-

The fair market value of unquoted equity shares = (A-L)/PE x (PV)

A = Book value of the assets in Balance Sheet as reduced by any amount paid as advance tax payment under the Income-tax Act and any amount shown in the balance sheet including the debit balance of the profit and loss account or the profit and loss appropriation account which does not represent the value of any asset;

L = Book value of liabilities shown in the Balance Sheet but not including the following amounts:

(i) the paid-up capital in respect of equity shares:

(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

(iii) reserves, by whatever name called, other than those set apart towards depreciation; ,

(iv) credit balance of the profit and loss account;

(v) any amount representing provision for taxation, other than amount paid as advance tax payment under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

(vi) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vii) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PE = total amount of paid up equity share capital as shown in the balance-sheet;

PV = the paid up value of such equity shares;”

7.3. From the literal reading of the above provision, it is clear that to apply the above provision, the following conditions have to be satisfied:

i. there is transfer of shares a company not being a company in which the public are substantially interested:

ii. the purchaser of the shares is a company not being a company in which the public are substantially interested;

iii. the consideration is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees; and

iv. the deemed income in the hands of the transferee shall be the aggregate fair market value of such property as exceeds such consideration.

8. From the facts of the case before us, it is seen that the property i.e., shares which are transferred are the shares of a company in which the public are not substantially interested. Since the transaction of sale and purchase of shares is between related parties and both the companies are companies in which the public are not substantially interested, we are of the opinion that the AO was justified in examining the applicability of the provisions of section 56(2)(viia) of the Act to the transaction of transfer of shares.

9. The next step for application of this provision is to arrive at the fair market value of the shares before comparing it with the consideration at which the shares are purchased by the assessee to examine if it was less than the aggregate fair market value of the property exceeding Rs.50,000. In the case before us, the AO had adopted the price at which the assessee has purchased the shares from two of the shareholders at a higher price of Rs.75.49 ps as the fair market value of the share. The question before us is, whether this is valid and as prescribed under the Act? Clause (b) of the explanation to clause (vii) to section 56(2) defines ‘fair market value’ to be the value as computed under the prescribed rule i.e., rule 11UA. According to the ld counsel for the assessee, where the Act prescribes a rule, it has to be strictly and mandatorily followed and further if the statute has conferred a power to do an act and has laid down the method in which that power is to be exercised, it necessarily prohibits the doing of the act in any other manner than that has been prescribed. In support of this contention, the assessee has relied upon various decisions cited supra. Let us now examine the applicability of the said decisions to the facts of the case before us

1. Bharaath Hari Singhania & others vs. CWT & others (cited supra): In this case, the Hon’ble supreme court of India was dealing with the validity of rule 1D of Wealth Tax Rules which prescribed break up method for valuation of unquoted equity shares for the purposes of valuing the net wealth of the assets of the assessee therein and the Hon’ble supreme court laid down the following principles which are relevant to the case before us:

a) Rule 1D prescribed for the valuation of unquoted equity shares has necessarily to be followed and WTO has no option either to follow or not to follow the same and the question whether the rule is mandatory or directory does not arise.

b) Valuation officer is as much bound by rules of valuation made under the Act as anybody else is. Since Rule 1D uses the word ‘shall’, it prima facie indicates its mandatory character.

2. Mrs. Prem Shamsher Singh vs CWT (cited supra): In this case, the Hon’ble dehi High court followed the judgement of the Hon’ble Supreme court in the above cited case of Bharat Hari Singhania and others.

3. Chandra Kishore Jha vs. Mahavir Prasad & others (cited supra): In this case, the Hon’ble Supreme Court was dealing with an election petition filed after the prescribed period of 45 days from the election and while examining the rules made for the said purpose and the appellants’ complaince thereto, it was held that ‘it is a settled salutary principle principle that if a stature provides for a thing to be done in a particular manner, then it has to be done in that manner and in no other manner.’

4. State of Uttar Pradesh vs Singhara Singh and others (cited supra) : In this case the Hon’ble Supreme Court was dealing with the validity of a confession not recorded in accordance with the procedure prescribed u/s164 of the Criminal Procedure Code and held that ‘if a statute has conferred a power to do an act and had laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any other manner than that which has been prescribed.’

5. Danish Aarthi vs Abdul Kapoor (cited supra): In this case hon’ble Madras High Court was dealing with an eviction petition and observing the the petitioner therein has not followed the procedure prescribed under section 8 of Tamil Nadu Buildings (Lease and Rent control) Act, 1960 and held that ‘when the statute prescribes to do a particular thing in a particular manner, the same shall not be done in any other manner than prescribed under the law. For coming to this conclusion, the court relied on the judgements of the Hon’ble Supreme Court cited above.

Though the facts and circumstances under which the above rulings have been given are distinguishable, we find that the legal principles laid down in the above judgments are clearly applicable to the facts of the case before us. Therefore the question before us is whether the A.O. can adopt the value at which the assessee acquires the shares of the same company on the same day for a higher consideration as the fair market value of the shares or whether FMV is compulsorily to be valued under Rule 11UA of the Act before applying the provisions of Sec.56(2)(viia) of the Act.

10. From a plain reading of the provisions which are reproduced above and also the precedents discussed above, it is seen that section 56(2)(viia) requires that before application of the said provision, the A.O. has to necessarily compute the fair market value and only then can compare the same with the consideration paid by the assessee and apply the said provision only if the conditions set therein are satisfied. In the case before us, undisputedly some of the shareholders have sold the shares at a much higher price than that at which the assessee has purchased the balance of the shares from other shareholders i.e., at Re.1. Though the A.O. has not computed the fair market value in accordance with Rule 11UA of the I.T. Rules, he had evidence before him to be satisfied that the market value of the shares was much higher than the value at which the balance of shares were transferred to the assessee. The AO has observed that “mainly the valuation of any property is based on fact as to what value the property would fetch if sold in open market but generally the details as to how much value an unlisted share would fetch will not be available and hence the formula is given to overcome that deficiency”. Since the market price of some of the shares at a higher value than Rs.1 was available, the AO has adopted the same as the fair market value. This stand of the AO could have been sustainable had the section provided that the FMV of an unquoted share shall be the value computed in accordance with the rule or the actual market value, if any, whichever is higher. But as can be seen from the Act and the rules provided there under, no such provision has been made. In fact, under the wealth tax Act, Section 7(1) defines the expression “value of an asset” as “the price which in the opinion of the WTO it would fetch if sold in the open market on the valuation date” but in the relevant provisions the definition of fair market value is given in the Act and method has also been prescribed thereunder.

11. On a careful reading of the judgments discussed above, it is seen that the Courts have held that where a method has been prescribed by the legislature, that method alone shall be followed for computation of the fair market value. The A.O. and the Ld. CIT(A) have not followed the relevant provisions for adopting or computing the fair market value of the shares, but have adopted the market value at which some of the shares have been purchased by the assessee as FMV. This, in our opinion, is not correct. As held by the Courts in the above judgments, the A.O. has to compute the fair market value in accordance with the prescribed method but cannot adopt the market value as fair market value under section 56(2)(viia) of the Act. The legislature in its wisdom has also given a formulae for computation of the fair market value which cannot be ignored by the authorities below.

12. We find that at para 4.12 of the assessment order, the AO has recorded that the assessee has furnished the valuation of the shares based on the working given under rule 11UA(c )(b) of the IT Rules, according to which, the fair market value of the shares is Rs.-64.48/- (i.e., the value of Optival share is at a negative figure) whereas the assessee has paid at Rs.1 per share. He has also observed that no basis is given by the assessee for adopting the rate of Rs.63.79 per share for purchase of shares by Sri Madhukar Reddy. He observed that there is no basis for the transacting in the shares at different rates and that this arrangement has been done to defraud the revenue of its taxes by transacting at abnormally low prices. Having regard to the above observations of the AO, we are of the opinion that if the AO was not satisfied with the working given by the assessee, he ought to have computed the FMV himself in the method prescribed under the rules but ought not to have adopted higher of the prices paid by the assessee for purchase of some of the shares of M/s Optival as even when the transactions are between the related parties, the provisions of section 56(2)(viia) can be applied only in accordance with the prescribed method and the difference between the price at which the assessee has purchased the shares and aggregate of the fair market value of the shares as computed can be brought to tax as deemed income in the hands of the assessee. For the above reasons, we are satisfied that the provisions of section 56(2)(viia) are not properly and correctly applied in the assessee’s case. In view of the same, the assessment order as well as the order of the Ld. CIT(A) are set aside and these issues including the issue raised in the additional ground of appeal are remitted to the file of the AO for reconsideration of the issue in accordance with law. The assessee’s grounds of appeal 3 to 5 and the addl. ground are accordingly treated as allowed for statistical purposes.

13. The ground of appeal No. 6 against levy of interest u/s.234C is consequential in nature and therefore, the this ground also is remitted to the file of the AO with a direction to give consequential relief if any to the assessee.

14. The ground of appeal No.7 is against initiation of penalty proceedings u/s 271(1)© of the Act and the same is dismissed as it is a premature ground at this stage.

15. In the result, appeal of the assessee is treated as allowed for statistical purposes.

Order pronounced in the open Court on 08.03.2016.

(B. RAMAKOTAIAH) ACOUNTANT MEMBER  (SMT. P. MADHAVI DEVI) JUDICIALMEMBER

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