Redemption of preference shares premium not taxable as deemed dividend

Facts and Issues of the Case

The assessee is a public limited company incorporated in the year 1994. The assessee is engaged in the business of developing, operating and maintaining industrial parks / Special Economic Zones. The assessee is a subsidiary of Ascendas Property Fund (India) Pte Ltd. [APFI]. The assessee has issued 0.5% redeemable non-cumulative preference shares on 6th January 2003 and the same is subscribed by APFI. The preference shares are issued at a face value of Rs.100 per share and are redeemable at any time after 24 months but not later than 9 months from the date of allotment.

The assessee filed its original return of income for AY 2010-11 on 28.09.2010 declaring NIL income, after set off of brought forward business loss of Rs.65,66,55,271. The return was processed u/s. 143(1) and subsequently the case was selected for scrutiny under CASS and notice u/s. 143(2) & 142(1) were issued. During the assessment proceedings a reference was made to the Transfer Pricing Officer (TPO) for determination of the Arm’s Length Price (ALP) of this international transaction assessee entered into with AFPI. The assessee has during the previous year relevant to AY 2010-11 redeemed some of the preference shares at a premium based on the valuation done the expert valuer by adopting the Net Asset Value (NAV) method. The TPO accepted the method of valuation adopted by the assessee . The TPO arrived at the redemption value at Rs.286.80 per share which resulted in an adjustment of Rs.29,95,66,000 that arose out of the difference between the redemption value adopted by the assessee and the TPO. The AO passed the final assessment order giving effect to the TP adjustment based on the letter filed by the assessee that the assessee would not be filing objections before the DRP and would prefer appeal with the CIT(Appeals).

The CIT(Appeals) held that the TP adjustment made by the TPO determining the value at which the preference shares should have been redeemed cannot be treated as income in the hands of the assessee by relying on the decision of the Mumbai High Court in the case of Vodafone India Services Ltd (2015) 53 taxmann.com 286 (Bombay). However since the ALP of the share price determined by the TPO is lesser than the price determined by the assessee, the CIT(Appeal) proposed to make addition to the extent of the same amount by treating it as deemed dividend. In this regard the CIT(Appeals) relied on the decision of coordinate bench of the Tribunal in the case of Fidelity Business Services India (P) Ltd v ACIT (2017) 80 Taxmann.com 230 (Bang – Trib). The assessee filed its response to the show cause notice before the CIT(Appeals) by submitting that the premium of redemption of preference shares cannot be considered as deemed dividend as per the provisions of section 2(22) of the Act and revenue authorities cannot re-characterize the transaction as deemed dividend. The assessee made detailed submissions before the CIT(Appeals) in this regard which were rejected by the CIT(Appeals) who proceeded to treat the premium on preference shares as deemed dividend. Aggrieved the assessee is in appeal before the Tribunal.

For AY 2010-11, the TPO determined the Arm’s length The common issue for these two years is the treatment of difference between issues in grounds raised for the assessment year 2010-11 is listed below:-

Ground No.1 – General.

Ground No. 2 – Levy of Dividend Distribution Tax [DDT] on share redemption.

Ground Nos. 3 to 5 – Valuation methodology of preference shares.

Ground No.6 – Consideration for redemption does not constitute ‘deemed dividend’.

Ground 7 – Applicability of section 115O(6).

Grounds 8 to 12 – Alternative conclusion of deemed dividend u/s. 2(22)(e).

Grounds 13 to 15 – Alternate grounds raised without prejudice to the above grounds.

The assessee raised 15 grounds and several sub-grounds on issues listed above and presented arguments with regard to the same during the course of hearing. Though we heard the rival submissions with regard to all the grounds, for the purpose of adjudication, we would consider only ground Nos. 3 to 5 with regard to valuation methodology of preference shares as the rest of the arguments would become academic once we decide on these grounds.

The ld. DR relied on the order of the CIT(Appeals). He also submitted that Rule 11UA(1)(c)(b) is amended only with effect from 01/04/2018 and prior to amendment the fair market value of the unquoted shares are to be arrived at basis the book value of assets and liabilities. The ld DR therefore contented that the amended rules cannot be applied in assessee’s case for the relevant assessment year. The ld. AR, in rebuttal, relied on the decision of the Supreme Court in the case of CIT v. Shravan Kumar Swamp & Sons [1994] 210 ITR 886 (SC) to state that amendment to Rules is retrospective and therefore the amended rules of Rule 11UA(1)(c)(b) would be applicable in the assessee’s case also.

Observation by the Court

The court had considered the rival submissions and perused the material on record. Before going into the issue under consideration the court will look at the provisions contained in Rule 11UA(1)(c)(b). As per rule 11UA(1)(c)(b) it is clear that for the purpose of arriving at the fair market value of the unquoted equity shares the immovable property should be considered at guideline value. Further rule 11UA(1)(c)(c) as extracted above states that the unquoted shares other than equity shares should be valued basis the price it would fetch if sold in the open market on the date of valuation as certified by an accountant. Though the rule 11UA(1)(c)(b) is applicable specifically to equity shares the spirit of the rule should be looked into. A combined reading of the said rule with rule 11UA(1)(c)(c) can be taken to mean that for the purpose of valuation of preference shares also the immovable properties to be considered at guideline value since the value based on the guidance note represents the economic and commercial value of the preference shares on the date of valuation. In the given case the assessee has obtained the valuation report from the Chartered Accountant (CA) which is placed on record complying with the requirement of the rule (1)(c)(c). In the certificate, for the purpose valuation of Equity and Preference shares, the guideline value of the land and building is considered by the CA which in our view is correct. In the light of these discussions, the court see no fault in the approach of the assessee in considering the guideline value of land building to arrive the fair value of preference shares that it would fetch in the open market on the valuation date and arriving at the premium value for redemption of the preference shares.

The method of valuation adopted as NAV is not disputed as the TPO has also applied the same method and impugned addition has arisen only due to the value of land and building considered by the TPO for arriving at the NAV. The court have in the above para held that considering the guideline value of land and building for the purpose of valuation of preference shares under NAV method is the right. Therefore the addition made by the TPO computing the differential premium basis the book value of assets is not sustainable. Since the court have held that there cannot be any addition made towards the premium on redemption of the preference shares, the addition made by the CIT(Appeals) considering the same as deemed dividend u/s.2(22)(e) also will not survive. The appeal for the assessment year 2010-11 is allowed in favour of the assessee.

The court will now take up the appeal for the assessment year 2009-10. The assessee raised 19 grounds including the legal ground challenging the jurisdiction of reassessment proceedings u/s. 147 (Ground no.2 to 5). The assessee filed its original return of income for AY 2009-10 on 30.9.2010 and subsequently filed revised return on 18.3.2010 declaring NIL income, after set off of brought forward business loss of Rs.25,57,11,432. The return was processed u/s. 143(1) on 29.3.2011. The case was selected for scrutiny under CASS and notice u/s. 143(2) & 142(1) was issued. Assessment was concluded on 29.12.2011 determining total income of the assessee at NIL, after set off of brought forward unabsorbed depreciation of Rs.38,79,20,733.

The AO concluded the reassessment by placing reliance on the order of the TPO for the AY 2010-11. The AO computed the value of preference shares at Rs.270.10 per share and the made an addition of Rs.37,16,41,000 being the difference between the actual premium of Rs.900 per share and premium as computed by the AO @ Rs.270.10 per share. The AO stated that the as per the India – Singapore Double Taxation Avoidance Agreement, the capital gain arising to a resident of Singapore from alienation of shares in an Indian Company is taxable only in Singapore and therefore proceeded make the addition u/s.93 of the Act. Aggrieved, the assessee preferred an appeal before the CIT(Appeals). The CIT(Appeals) held that addition made by AO u/s. 93 cannot survive. However, the CIT(A) proceeded to retain the addition by stating that excess premium paid by the assessee on redemption of preference shares would constitute deemed dividend u/s. 2(22) and therefore the assessee is liable to pay DDT u/s. 115O of the Act. Aggrieved, the assessee is in appeal before the ITAT.

With regard to the valuation of preference shares, the ld AR reiterated the submission earlier made for AY 2010-11. Without prejudice the ld AR submitted that the premium of redemption of preference shares, cannot be treated as deemed dividend u/s.2(22). The ld AR submitted that for the purposes of redemption, the assessee has utilised the securities premium as defined in section 78 of the Companies Act, 1956 which is not part of accumulated profits as defined in explanation 2 to section 2(22). In this regard, the ld AR relied on the decision of the Delhi ITAT in DCIT vs. MAIPO India Ltd [2008] 24 SOT 42 (Delhi) wherein while dealing with the provisions of section 78 of the Companies Act it is held that section 78 places a statutory bar on the usage of securities premium whereby the same can be utilised only for the purposes mentioned therein and not for any other purposes. It was submitted that one of the purposes envisaged is the payment of premium on the redemption of shares and the payment of dividend from securities premium is prohibited by Companies Act. The ld AR drew our attention to the fact that the accounting entries in the books of accounts of the assessee reflect that the payment was made from a specific reserve and not a free reserve as envisaged under section 2(22) and owing to the limited usage of securities premium granted by the Companies Act, any declaration of dividend from such specific reserve is not permitted under the Companies Act. Therefore the ld AR submitted that, the payment made to APFI cannot be considered as dividend and hence cannot be deemed as dividend under section 2(22) of the Act.

In connection with the contention that the payments to AFPI is dividend under section 2(22)(d) the ld AR submitted that section 2(22)(d) states that any distribution made to the shareholders of the company on reduction of capital shall be considered as deemed dividend to the extent of its accumulated profits. The ld AR also submitted that there is a distinction between the terms-‘redemption of shares’ and ‘reduction of shares’ and two different sections of the Companies Act deals with them. Therefore it was submitted that redemption of preference shares cannot be considered as ‘reduction’ of share capital. Reliance in this regard is placed on the decision of the Mumbai Tribunal in Parle Biscuits Pvt Ltd. v ACIT. Further the ld AR submitted that even otherwise, Item (i) of the exceptions to section 2(22) state that a distribution made in accordance with clause (d) of section 2(22) shall not apply to distributions of share, the holder of the which is not entitled to a share in the surplus assets on liquidation and a preference shareholder is not entitled to participate in the surplus assets on liquidation. Therefore, the provisions of section 2(22)(d) of the Act is not applicable and hence no DDT is payable.

The CIT(Appeals) alternatively invoked provisions of section 2(22)(e) for treating the premium on redemption of preference as deemed dividend and in this regard the ld AR drew our attention to the provisions of section 2(22)(e) which deals with payment by a closely held company by way of advance or loan to a shareholder and requires payment of a ‘repayable’ amount to shareholders. Such payment to the extent of accumulated profits of the company shall constitute dividend and this is subject to the recipient shareholder being a beneficial owner of shares holding not less than 10% of voting power. The ld AR submitted that in the present case, the impugned payment is towards consideration for redemption and is not an amount in nature of loan or advance which is repayable in future. It is further submitted that there would be no occasion for APFI to repay or return the amounts received on redemption. The ld AR also submitted that section 2(22)(e) entails a distribution from free reserves and as discussed earlier, securities premium cannot be utilised for the payment of dividend under the Companies Act. In addition to the above submissions the ld AR submitted that section 2(22) provides instances where distribution of accumulated profits would not constitute dividend and that a distribution to a shareholder who is entitled to a fixed rate of dividend with or without a right to participate in the profits cannot be considered as deemed dividend. In assessee’s case since APFI is a preference share holder who is entitled to a fixed rate of dividend, any distribution made to them cannot be considered as dividend under section 2(22)(e) for the purposes of the Act.

Without prejudice to the above submissions, ld AR submitted that the assessee is engaged in developing, operating and maintaining a SEZ and therefore would be covered by section 115-0(6) which states that no DDT shall be paid by an assessee engaged in developing, developing and operating or developing, operating and maintaining a Special Economic Zone (SEZ) on any profits distributed or paid on or after 1st April 2005 out of current year income either in the hands of the developer or the person receiving it. In the present case the assessee’s profits for the year is less than the excess premium sought to be taxed is less than the profits of the year [Profit and loss account on Page 76 of paperbook] and therefore the amount paid or distributed by the Appellant is covered by section 115-0(6) of the Act and there would be no liability to pay DDT. The ld AR also presented arguments distinguishing the case of Fidelity Business Services (P.) Ltd (2017) 164 1TD 270 relied on by the CIT(A) by submitting that in the case of Fidelity (supra)the shares under consideration were equity shares.

The court have while considering the appeal for AY 2010-11 in para 12 and 13 have held that the considering the guideline value of land and building for the purpose of valuation of preference shares under NAV method is the right and therefore there cannot be any addition made towards the difference the premium amount. For the year under consideration, the facts and the issue are the same. The AO has re- opened the assessment, on the basis of the valuation done by the TPO for AY 2010-11 and the AO has adopted the same approach of considering the book value of land and building for the purpose of computing the value per preference shares. Therefore our decision for AY 2010-11 is applicable for AY 2009-10 also.

From the plain reading of the above provisions, it is clear that sub-clause (d) is applicable when there is any distribution by the company to its shareholders by a company on the reduction of its capital and in order to attract clause (d), the payment should be by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares. In the given case, the payment made by the assessee towards premium of redemption of preference shares is neither towards reduction of share capital nor towards advance or loan. The court are therefore in agreement with the various arguments put forth by the ld AR in this regard. The court are of the considered view that the excess premium paid to APFI by the assessee on redemption of preference shares cannot be taxed u/s.2(22)(d) or 2(22)(d) and delete the addition made by the CIT(Appeals). For both the assessment years the ld AR made submissions with regard to all the grounds including legal grounds for AY 2009-10. In the light of our decision on valuation of the preference shares and treatment of excess premium as deemed dividend, the rest of arguments have become academic and therefore the grounds pertaining to the same do not warrant separate adjudication.