ITAT deletes addition for share premium as Assessee established identity, genuineness & creditworthiness of investor

According to Section 56(1) of the Income Tax Act, 1962, 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 other heads.

According to Section 56(viib) of the Income Tax Act, 1962, where a company, not being a company in which the public are substantially interested, receives in any previous year, from any resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to the head “Income from other sources”

However, this clause shall not apply where the consideration for issue of shares is received—

• by a venture capital undertaking from a venture capital company or a venture capital fund; or
• by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

Let us refer to the case of ITO Vs M/s Heckyl Technologies Pvt.Ltd. (ITAT Mumbai) where shares were issued at premium were taxed as income from other sources under section 56(1) by the AO.

Alternate Issue raised was whether such income can be considered as disallowed under Section 68 which pertains to unexplained cash credits? According to Section 68 of the Income Tax Act,where any sum was found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the AO, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

Where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless:-

• the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and
• such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory

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Facts of the Case

• The assessee was engaged in the business of brokerage’ financial institutions and fund managers etc.
• The assessee filed return of income declaring a loss. The case of the assessee was selected for scrutiny and show cause notice was duly served upon the assessee.
• During the course of assessment proceedings the AO observed that the assesee had issued shares at a premium and accordingly the assessee was asked to clarify the share premium received.
• The assessee replied by filing various explanation from time to time. A reference was made to the United Kingdom tax authorities from where the major funds were received in books of Seed Fund 2 International Mauritius (SFM)

• The AO noted that the shareholders of Mauritius based company had contributed the capital as equity funds and out of that; partial funds were transferred from Seed Fund 2 International to the assessee company.
• The assessee company in turn had allotted the Redeemable Preference Share as Compulsorily Convertible Preference Share (CCPS) of face value Rs. 10 each.
• Upon allotment of shares’ the share premium was immediately transferred to Reserve and surplus.

Contention of Assessing Officer (AO)

• The AO was not satisfied with the genuineness of the transactions and was of the view that such types of private equities share premiums were nothing but the profits in the hands of the company and liable to be taxed as income from other sources under section 56(1).
• Accordingly’ the same was added u/s 56(1) as income from other sources.
• AO also recorded that the said sum may be added u/s 68 as assessee had failed to prove the genuineness and creditworthiness of the investors.
• The share premium credited through reserve and surplus account was added as unexplained cash credit u/s 68.
• Aggrieved with the order of the AO, assessee filed an appeal before the Commissioner of Income Tax (Appeals)

Observations of CIT(A) on references made by AO

• The AO had mentioned in his order that he had made two references to the tax authorities in Mauritius and the UK.
• These references were made under section 90 (pertains to Agreement with foreign countries or specified territories under Double Taxation Relief) and had been accordingly made through the Competent Authority.
• However, there was no mention of either the details of the exact reference made to either country or the receipt of any information or the results of the Investigation of the AO subsequent to the obtaining of the said information.
• It was clear from the order under appeal that the appellant had not been challenged with any information obtained under section 90.
• In these circumstances, CIT(A) found merit in the argument of the assessee that nothing had been found against the appellant as a result of the exercise of the powers available to the AO under section 90 of the Act.

Observations of CIT(A) on contention of AO that the allotment was done before the date the funds were received and before the date of allotment as given to the RBI

• It was not clear as to how the AO reached this conclusion, as there was no material available to substantiate this finding.
• Even if it was true, there was no scope for contemplating an addition either under section 56 or under section 68 on the basis of such discrepancies.
• The AO has himself mentioned in his order that the reason for distorting the date of allotment given to the RBI was to escape the penal provisions of FEMA.
• However alleged fudging of dates would not be of any effect under the Income Tax Act.

Observations of CIT(A) on contention of AO that the receipt by the appellant was from entities which were neither venture capital companies nor venture capital funds

• AO’s argument was that SFM was neither a venture capital company nor a venture capital fund in terms of section 10(23FB) of the Act.
• According to section 56(2)(viib), any consideration for issue of shares exceeding the face value of such shares has to be charged to tax, unless the consideration has been received from a venture capital company or a venture capital fund.
• The said provision of section 56(2)(viib) had been inserted by the Finance Act 2012 with effect from 1st April 2013.
• As such, it would be / applicable only from AY 2013-14 onwards, while the AY under consideration was AY 2012-13.
• According to CIT(A), the AO had no basis for invoking the provisions of section 56(2)(viib) of the Act.

Observations of CIT(A) on the fact that the AO had invoked the provisions of section 68

• AO had given the details furnished by the appellant viz. copy of account of the investor-company along with its name and addresses.
• However, according to the AO, the genuineness and creditworthiness of the investor had not been addressed. In this context, CIT(A) referred the documentation filed by the appellant.
• Assessee had filed a copy of the PAN card of SFM along with a copy of the first page of its relevant return of income.
• It had also filed audited financial statements of SFM. As per the Statement of Financial Position (roughly equated with the balance sheet), while the total assets of SFM were US$ 17.93 million, its total liabilities were only US$ 0.012 million, placing its net asset base at US$ 17.92 million.
• At an exchange rate of Rs. 67 per USD, this would amount to net assets of over Rs 120 crores.
• The investment of the said Fund in the appellant-company of Rs. 2.49 crores was a little over 2% of its net assets.
• The appellant has also furnished copies of the Certificate of Incorporation issued by the Registrar of Companies of Mauritius, the Business License issued by the Financial Services Commission of Mauritius and the Tax Residency Certificate issued by the Mauritius Revenue Authority, the last document having been submitted for two Mauritian financial years.

• The appellant also submitted its documentation filed with the RBI (form FC­GPR). It also filed a copy of the acknowledgment of the said FC-GPR.
• It then filed a copy of the bank account of SFM highlighting the deposit of monies which were eventually transferred to the appellant.
• It also filed a copy of its bank account maintained with State Bank of India to demonstrate the inflow of funds from Mauritius.
• After careful consideration of all these documents, CIT(A) was of the opinion that appellant had more than satisfactorily acquitted itself when it comes to establishing all the three crucial components required to be validated under section 68 of the Act viz identity, genuineness and creditworthiness of the investor.

Reference to older cases by CIT(A)

• The Supreme Court also had occasion to go into the legality of this matter in the case of CIT v. Allahabad Bank Ltd. It was held that the share premium account had to be included in the paid-up capital account, thus leading to it being treated on a par with the paid-up capital.
• In the case of CIT v. Standard Vacuum Oil Co, it was held that premium realized on issue of shares was not in the nature of a revenue receipt and is hence not chargeable to tax.
• The Bombay High Court too had occasion to go into this matter in its decision rendered in the case of Vodafone India Services (P) Ltd. It had held that the amounts received on issue of share capital including the premium – are undoubtedly on the capital account.

Thus, the Revenue was stopped from charging the said premium to tax in the absence of any explicit legislative sanction. The appellant-company was far from being a non company or a zero balance one. It was in possession of assets far in excess of the premium charged even on the day of the charge of such premium. In these circumstances, there would be all the more reason for not charging to tax the share premium collected by the appellant.

Therefore in the appellate proceedings the CIT(A) allowed the appeal of the assessee. Aggrieved with the order of the CIT(A), Revenue appealed before Income Tax Appellate Tribunal (ITAT)

Proceedings of ITAT

• The assessee had entered into a share purchase agreement with Seed fund 2′ International and Seed fund 2 ‘India for purchases of shares.
• The Appellant Company submitted that in light of the background of Seed fund 2′ International’ Mauritius’ the funds in form of share capital received by the appellant company from Seed fund2 International’ Mauritius stood fully explained.
• Further the above investment done by the investor was being reflected in their audited accounts.
• In fact the investment made by SeedFund2 International in the appellant company was a Scheme floated by the Indian Seed Investment Trust which was a Trust based in India and also registered with SEBI as Venture Capital Fund.

• The Certificate of approval by SEBI was submitted to the AO. As stated by the assessee SEEDFUND2 India has filed its Return of Income for A.Y. 2012-13. The Return of Income, copy of computation and acknowledgement of Returns filed were submitted by the appellant company.
• The investments in the appellant company were being reflected in the audited balance submitted to the AO during the course of hearing.
• Seed Fund 2 India Ltd was registered under SEBI as Venture Capital Fund Category.
• The CIT(A) had passed a very reasoned and speaking order justifying the deletion of additions by dealing with all the issues as raised by the revenue
• ITAT did not find any defect legal or otherwise in the order of the CIT(A) and hence the conclusion drawn by the CIT(A) was affirmed
• The appeal of the Revenue was dismissed by ITAT.

As the explanation provided by the assessee proving the identity, genuineness & creditworthiness of investor was found to be satisfactory to the CIT(A) and ITAT share premium was not added to the income of the assessee under Section 68 and 56.

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