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Order of Commissioner of Income Tax (Appeals) [CIT(A)]

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Is Section 54F deduction allowable where an independent building having multiple residential units is treated as ‘one residential unit’?

Is Section 54F deduction allowable where an independent building having multiple residential units is treated as ‘one residential unit’?

Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price.

The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act. To save tax on these capital gains, a few capital gains exemption/deductions are available under sections 54, 54B, 54D, 54F etc. As per the provisions of these sections, the amount is required to be reinvested in specified investment types before the specified period. However, if the due date of filing income tax returns falls before the expiry of the specified period, the amount of capital gains is required to be invested temporarily in the Capital Gains Account Scheme which can be easily withdrawn at the time of investment in the specified instrument.

What is Section 54F of the Income Tax Act?

The income tax law provides for certain situations where such capital gains will not be subject to tax. Section 54F provides one such exemption. In the case of an assessee being an individual or a HUF, if the capital gain arises from the transfer of any long-term capital asset, not being a residential house (original asset) and the assessee has within a period of 1 year before or 2 years after the date on which the transfer took place purchased, or has within a period of 3 years after that date constructed, one residential house in India (new asset), the capital gain shall be dealt with in accordance with the following provisions of this section:

  • if the cost of the new asset is not less than the net consideration in respect of the original asset, the whole of such capital gain shall not be charged under section 45
  • if the cost of the new asset is less than the net consideration in respect of the original asset, so much of the capital gain as bears to the whole of the capital gain the same proportion as the cost of the new asset bears to the net consideration, shall not be charged under section 45

Let us refer to the case of Halesh K.C. Vs ITO (ITAT Bangalore) where the issue raised was whether benefit of Section 54F is allowable where an independent building having multiple residential units is treated as ‘one residential unit’

Facts of the Case:

  • The assessee along with other family members had sold an immovable property located in Bangalore on 20-08-2015.
  • The assessee worked out long term capital gain of Rs.1,50,20,000 and claimed deduction of entire amount u/s 54F.
  • The AO noticed that the assessee had received a building by way of gift on 13.8.2015 and the said building consisted of ground floor, first floor and second floor.
  • The AO also deputed his inspector to physically inspect the property.
  • The Inspector reported that the Ground floor was having a garage and one residential unit; first floor was having two 1BHK flats and second floor was having 2 single (with bath) units.
  • The AO, accordingly, took the view that each of the unit was a separate house.
  • Since deduction u/s 54F was not permitted, if the assessee was having more than one house property, the AO rejected the claim for deduction u/s 54F.

Order of Commissioner of Income Tax (Appeals) [CIT(A)]

The CIT(A) also confirmed the same and took support of decision rendered by Bangalore bench of Tribunal in the case of Ramaiah Harish. Aggrieved with the order of the CIT(A), assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT)

Observations of ITAT on decisions of earlier cases:

ITAT noticed that the decision rendered by the Tribunal in the case of Ramaiah Harish (supra) was an ex-parte order and the same was recalled by the Tribunal later. Hence the CIT(A) could not have placed his reliance on the above said decision.

The question, whether each floor of a single standalone building should be considered as separate house was examined by the co­ordinate bench in the case of Shri Bhatkal Ramarao Prakash vs. ITO. According to the said case:

  • As far as the case of the AO that assessee has purchased two properties under Sale Deed.
  • Actually, this was a single piece of property owned by Smt. Janaki Iyengar.
  • She constructed a residential house in ground floor in the year 1937 and the first floor in the year 1962-63.
  • Janaki Iyengar died and the legatees under the will sold their respective shares in one property to the Assessee.
  • The entire property constituted single house but was bifurcated with two door numbers for the ground and first floor with common entrance in the ground floor only to earmark the share of each beneficiaries.
  • The property otherwise constituted a single property, though they have two different door nos.
  • In such circumstances, the assessee has purchased only one property and not two properties.
  • In this regard, the decisions cited by the Counsel for the assessee supported the plea of the assessee viz., the decision of the Delhi High Court in the case of CIT Vs. Gita Duggal (Delhi).
  • In the aforesaid decision, the facts were that the assessee entered into a development agreement pursuant to which the developer demolished the property and constructed a new building comprising of three floors.
  • In consideration of granting the development rights, the assessee received Rs. 4 crores and two floors of the new building.
  • The AO held that in computing capital gains, the cost of construction of Rs. 3.43 crores incurred by the developer on the development of the property had to be added to the sum of Rs. 4 crores received by the assessee.
  • The assessee claimed that as the said capital gains was invested in the said two floors, she was eligible for exemption u/s 54.
  • The AO rejected the claim on the basis that the units on the said floors were independent & self-contained and not “a residential house” and granted exemption for only one unit.
  • The CIT(A) and Tribunal upheld the assessee’s claim by relying on B.Ananda Basappa (Kar) and K.G. Rukminiamma (Kar).
  • On appeal by the department, the High Court dismissed the appeal of the revenue.
  • The Court observed that as held in B.Ananda Bassappa (SLP dismissed) & K G Rukminiamma, the Revenue’s contention that the phrase “a” residential house would mean “one” residential house was not correct.
  • The expression “a” residential house should be understood in a sense that building should be of residential in nature and “a” should not be understood to indicate a singular number.
  • Also, section 54/54F uses the expression “a residential house” and not “a residential unit”.
  • Section 54/54F requires the assessee to acquire a “residential house” and so long as the assessee acquires a building, which may be constructed, for the sake of convenience, in such a manner as to consist of several units which can, if the need arises, be conveniently and independently used as an independent residence, the requirement of the Section should be taken to have been satisfied.
  • There was nothing in these sections which required the residential house to be constructed in a particular manner.
  • The only requirement was that it should be for the residential use and not for commercial use.
  • If there was nothing in the section which required that the residential house should be built in a particular manner.
  • According to ITAT, the income tax authorities could not insist upon that requirement.
  • A person may construct a house according to his plans, requirements and compulsions.
  • A person may construct a residential house in such a manner that he may use the ground floor for his own residence and let out the first floor having an independent entry so that his income was augmented.
  • It was quite common to find such arrangements, particularly post-retirement.
  • There may be several considerations for a person while constructing a residential house.
  • The physical structuring of the new residential house, whether it is lateral or vertical, could not come in the way of considering the building as a residential house.
  • The fact that the residential house consists of several independent units could not be permitted to act as an impediment to the allowance of the deduction u/s 54/54F.
  • It was neither expressly nor by necessary implication prohibited.
  • ITAT was therefore of the view that the Assessee was entitled to claim deduction u/s.54F in respect of investment in the property.

Observations of ITAT on miscellaneous application by Revenue

ITAT also noticed that the revenue had filed a miscellaneous application against the said order passed by the Tribunal and the same was rejected by the order passed by the co-ordinate bench with the following observations:

  • In this miscellaneous petition, the revenue has contended that since the Tribunal has placed reliance on the decision of the High Court of Karnataka rendered in the case of B. Ananda Bassappa (supra) and K G Rukminiamma (supra) and since by the Finance Act, 2014, section 54F was amended by substituting the words “a residential house” with “one residential house” and since the assessment year in this appeal is after the aforesaid amendment, the conclusions drawn by the Tribunal were incorrect and suffered from an apparent mistake on the face of record and should be rectified suitably.
  • ITAT was of the view that there was no mistake, much less an apparent mistake, in the order of the Tribunal.
  • The Tribunal had clearly given a finding that the property at N.R. Colony belonged to one owner, Smt. Janaki Iyengar.
  • As per the Will of Smt. Janaki Iyengar, the Ground Floor of the premises which was numbered as Door No.37 was given to Smt. Janaki’s sister, Dr. M. Vaidehi and the 1st Floor numbered as Door No.37/1 was given to Smt. Janaki’s nephew, Shri P. Ramanuja Chari.
  • Both these owners of Ground Floor and 1st Floor sold the property to the assessee.
  • ITAT clearly observed that the entire property constituted one residential house, but was bifurcated with two Door Nos. for Ground Floor and 1st Floor with common entrance in Ground Floor only to earmark the share of each beneficiary and that otherwise the property constitutes a single property, though it had two different Door Nos.
  • ITAT had reached the conclusion that assessee had purchased only one property and not two properties.

The view taken was that an independent building can have a number of residential units and it would not lose the character of “one residential house”. Accordingly, ITAT was unable to agree with the view taken by the tax authorities that each floor of the individual house/each portion in a floor was separate house property. Accordingly, ITAT set aside the order passed by CIT(A) on this issue and held that the house property received by the assessee was “one residential house” only within the meaning of sec.54F of the Act. Accordingly, ITAT was of the view that the reasoning given by the AO to reject the claim for deduction u/s 54F was not justified. With these observations, ITAT restored this issue to the file of the AO for allowing the deduction u/s 54F of the Act in compliance with the above decision.

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Tribunal has no power of enhancement – SC

Tribunal has no power of enhancement – SC

Income Tax Appellate Tribunal (ITAT) is a quasi-judicial institution which specializes in dealing with appeals under the Direct Taxes Acts. According to Section 254, the Appellate Tribunal may, after giving both the parties to the appeal an opportunity of being heard, pass such orders thereon as it thinks fit. On a question of fact, the Appellate Tribunal order is a final order and no appeal can lie to High Court against this order. However, if the fact finding had not been done properly by the Appellate Tribunal, the assessee can file a writ petition to the High Court challenging the fact-finding process. If the High Court is satisfied that the claim of the assessee is correct then it will direct the Appellate Tribunal to conduct the fact finding as per the proper procedure.

Let us refer to the case of MCorp Global Pvt. Ltd. v. CIT (2009), where the issue under consideration was whether the Tribunal could take back a benefit conferred by the AO or enhance the assessment or not.

Facts of the Case:

  • During the relevant assessment year, the assessee carried on the business of trading in lamination machines & binding and punching machines.
  • In addition, it was also engaged in the leasing business.
  • During the relevant year, the assessee had bought 5,46,000 soft drink bottles from M/s Glass & Ceramic Decorators worth Rs. 19,54,953.
  • The bottles were directly supplied to M/s Coolade Beverages Pvt. Ltd in terms of a Lease.
  • By an assessment order, the AO found that M/s Coolade had received only 42,000 bottles out of the total of 5,46,000 bottles receivable by them from the assessee and that the remaining bottles stood received after 31.3.1991, i.e., between the period 3.4.1991 and 18.4.1991 and consequently, the AO restricted the depreciation only to 42,000 bottles and consequently dis-allowed the depreciation of Rs. 18,04,572.

Order of Commissioner of Income Tax (Appeals) [CIT(A)]

  • In Appeal, the CIT(A) after formulating the “User Test” remanded the matter to the AO who on remand held that all 5,46,000 bottles stood paid for and dispatched before 31.3.1991 and, therefore, the assessee was entitled to 100% depreciation on all 5,46,000 bottles.
  • On appeal, the Tribunal held that the assessee was not entitled to depreciation at all. Therefore, the entire claim was directed to be disallowed.
  • Confirming the decision of the Tribunal, the High Court (HC) held that the appellant (assessee) was not entitled to claim depreciation under Section 32(1)(ii) of the Income-tax Act, 1961 in respect of two separate transactions dated 15.2.1991 and 15.3.1991.

Observations of Supreme Court (SC)

The assessee relied on the Supreme Court’s judgment in the case of Hukumchand Mills Ltd. v. CIT (1967) (SC) to argue that the Tribunal does not have the power to enhance an assessment. The department supported the order of the Tribunal

The Supreme Court accepted the assessee’s contention and held that the Tribunal has no power to take back a benefit conferred by the AO, i.e., the Tribunal does not have the power of enhancement.

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Are expenses incurred prior to the commencement of the business allowable as deduction?

Are expenses incurred prior to the commencement of the business allowable as deduction?

When anyone starts a business some expenditure is incurred in the form of preparation of Memorandum of Association, feasibility report, project report this is called preliminary expenditure. Section 35D of the Income Tax Act lays down the requirements, the amount of preliminary expenditure, and other conditions to be satisfied to claim the expenditure. Expenditure incurred for the following items can be claimed as a deduction:

  • Preparation of feasibility report
  • Preparation of project report
  • Conducting market survey necessary for business
  • Engineering services relating to business
  • Preparation of agreements between the assessee and any other person for setting up and or conduct of business
  • Drafting and printing of Memorandum of Association (MoA) and Articles of Association (AoA)
  • Incorporation of a company
  • Public issue of shares or debentures of the company

The issue concerning the nature and taxability of ‘income’ and ‘expenditure’ pertaining to the ‘pre-commencement business/commercial production’ period, in newly incorporated business enterprises and ‘start-ups’ has always remained a confusing and litigative issue with Revenue Authorities considering the expenses as capital in nature and income as revenue in nature and the assessee’s wishing to treat the same in exactly the opposite manner. Let us refer to the case of GCO Technologies Centre Pvt Ltd vs ITO, which dealt with a similar issue.

Facts of the Case:

  • Assessee company was engaged in the business of providing software outsourcing services exclusively to its parent company viz. M/s Global Conference Organizers, B.V, Netherland.
  • During the course of the assessment proceedings, it was observed by the AO that the assessee company had entered into a service agreement with its parent company.
  • The AO called upon the assessee to explain as to why the expenses made prior to the commencement of its business amounting to Rs.12,26,063 may not be disallowed being in the nature of pre-commencement expenses.
  • In reply, it was submitted by the assessee that as the infrastructural facilities were set up, business assignments were explored/negotiated and manpower was recruited by 02.05.2009, therefore, its aforesaid claim of expenses incurred during the period 20.04.2009 to 30.07.2009 was in order and allowable as deduction u/s 37(1) of the Act.
  • However, the A.O not finding favour the aforesaid claim of the assessee disallowed the aforesaid expenses of Rs. 12,26,063 (net of reimbursement), by treating them as pre-commencement expenses within the meaning of Sec. 35D of the Act.

Order of Commissioner of Income Tax (Appeals) [CIT(A)]

  • Aggrieved, the assessee assailed the assessment order in appeal before the CIT(A).
  • As regards the disallowance of the pre-commencement expenses of Rs.12,26,063 by the A.O, the CIT(A) principally upheld the same.
  • However, taking cognizance of the fact that the said expenses would be squarely covered by Sec. 35D of the Act, the CIT(A) directed that 1/10th of the aforesaid expenditure be allowed to the assessee for each 10 successive previous beginning from the year under consideration
  • The assessee being aggrieved with the order of the CIT(A), appealed before the Income Tax Appellate Tribunal (ITAT)

Observations of ITAT

  • On a perusal of the records, ITAT found, that the assessee company had during the period May, 2009 to July, 2009 inter alia incurred expenses towards salaries of the employees, electricity expenses (nominal amount), internet expenses, office expenses, office rent, staff welfare expenses and technical consultancy fees etc., which therein proved that the assessee company, an entity belonging to service industry, had set up or in fact established its business which was ready for commencement.
  • In this regard, it would be relevant to point out, that as the assessee company which was engaged in the business of providing software development services exclusively to its parent company belonged to the service industry, therefore, the incurring of the aforesaid expenditure i.e payment of rent, salary expenses, electricity expenses, etc., therein revealed, that its business during the aforesaid period under consideration was though set up but had yet not commenced.
  • The period can safely be held to be the interval between setting up of the business and its commencement.
  • In ITAT’s view, all expenses which were incurred by an assessee during the interregnum period between setting up of its business and commencement of the business, were permissible as a deduction under Sec. 37 of the Act.

Reference by ITAT to an earlier case

  • ITAT’s view was fortified by the judgment of the High Court of Bombay in the case of CIT Vs. Axis Private Equity Limited.
  • In its aforesaid order, the High Court relying on its earlier judgment in the case of Western India Vegetables Products Ltd. Vs. CIT (1954), had held, that business is said to have been set up when it is established and ready to commence.
  • As observed by the High Court, there may be an interval between a business which is set up and a business which is commenced.
  • However, all expenses incurred during the interregnum period between setting up of business and commencement of business would be permissible deductions.
  • Observing, that the assessee before them had set up its business, which, however, was disallowed by the A.O on the ground that the assessee had not yet commenced its business, the High Court had upheld the view taken by the Tribunal which had allowed the assessee’s claim for deduction of the expenses incurred during the interregnum period.
  • In fact, the High Court in its aforesaid order had referred to an order of ITAT in the case of HSBC Securities India Holdings Pvt ltd, wherein the assessee’s claim for business expenditure incurred after setting up of business prior to its commencement was allowed by ITAT.

In the backdrop of the aforesaid facts, it was concluded that the expenses incurred by an assessee after setting up of its business and prior to the commencement of the same would be allowable as deduction for the purpose of computing its taxable income

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Can exemption of Section 11 can be withdrawn on omission of Section 10(20A)?

Can exemption of Section 11 can be withdrawn on omission of Section 10(20A)?

Charitable organization is a kind of institution or a business that falls under the category of NPO or non-profit organization and can be based on providing educational, religious or public interest activities. There are different kinds of activities of the charitable organizations. Some of them offer relief to the needy people who are in distress, poverty or are underprivileged.

There are also some who are related to educational, scientific or religious affiliations. Some of the activities of charitable organization also include the creation of public building and monuments and take care of them. All these are done by the donations that a charitable organization gets. Due to their distinct organisation and objective entire income of such charitable or religious trusts are taxed as per the provisions of section 11-13 of the Income Tax Act, 1961, which provides for various tax benefits to them.

What benefit under income tax is provided to trusts?

Trust formed for charitable or religious purposes which are not intended to do commercial activities are allowed various benefits under the Income-Tax Act, inter-alia, exemption under section 11.

What do you mean by religious or charitable purpose?

The term religious purpose is not defined under the Income-Tax Act. Section 2(15)​ of the Income Tax Act defines “charitable purpose” to include relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility.

However, the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess, fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity, unless:

  • such activity is undertaken in the course of ​​carrying out of such advancement of any other object of general public utility and
  • the aggregate receipts from such activity or activities during the previous year, do not exceed 20% of the total receipts, of the trust or institution undertaking such activity or activities, of that previous year

How is income from property held for charitable or religious purposes by is trust, taxed?

According to Section 11 of the Income Tax Act, the following income from property held for charitable or religious purposes shall not be included in the total income of the previous year

  • income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and
  • where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property

In simple words,

15% of gross receipts from such trust property – Exempt

85% of gross receipt from such trust property

  • Income Applied for Charitable Purposes in India – Exempt to the extent to which applied for the following purposes:
    1. Purchase of capital asset
    2. Repayment of loan for purchase of capital asset
    3. Revenue Expenditure
    4. Donation to trust registered u/s 12AA or u/s 10(23C)
  • In case whole or part of income is not received during that year in which it is derived. Income deemed to be applied for charitable purpose in India and exempt shall be:
    1. Income is applied for charitable purpose in India in the year of receipt or in the immediate succeeding year.
    2. Assessee submits a declaration to the AO on or before the due date of filling of return as per section 139(1) that such income shall be applied for such purpose in the year of receipt or succeeding year.
  • In any other case exempt income shall be:
    • Such income is applied in above mentioned charitable purposes in the immediately succeeding year.
    • Assessee submits a declaration to the AO on or before the due date of filling of return as per section 139(1) that such income shall be applied for such purpose in the immediate succeeding year.

Let us refer to the case of JCIT(OSD), (Exemptions) Vs Patiala Improvement Trust (ITAT Chandigarh), where the issue under consideration was whether exemption of Section 11 can be withdrawn on omission of Section 10(20A)?

Facts of the Case:

  • The assessee society registered under section 12A of the Act, 1961 and subsequently withdrawn, filed its return of income for the assessment year under consideration declaring nil income after claiming exemption u/s 11 of the Act.
  • The AO noticed that during the year relevant to the assessment year under consideration the assessee carried on the business of sale and purchase of residential plots and commercial properties and earned huge net profit, which did not fall within the ambit of the advancement of any other object of general public utility under section 2(15) of the Act.
  • Accordingly, the AO asked the assessee to justify its claim and after hearing the assessee rejected the claim of the assessee.
  • The AO rejected the claim of the of the assessee and after making addition on account of disallowance of donation amounting and disallowance of service Tax paid, passed Assessment Order u/s 143(3).

Order of Commissioner of Income tax (Appeals) [CIT(A)]

  • The assessee challenged the assessment order before the CIT(A).
  • The CIT(A) relying on the decision of the ITAT in the case of Hoshiarpur Improvement Trust Vs. ITO and the decision of the ITAT Chandigarh Bench in assessee’s own case, allowed the appeal of the assessee.
  • Feeling aggrieved by the said findings of the CIT(A), the Revenue appealed before the Income Tax Appellate Tribunal (ITAT).
  • The only grievance of the Revenue is that the CIT (A) has wrongly held that the assessee is entitled for exemption u/s 11 of the Act.

Observations of ITAT on the previous ruling of ITAT on assessee’s own case

  • The Coordinate Bench had decided the identical issue in favour of the assessee in assessee’s own case for the A.Y. 2012-13.
  • In the said case, the assessee submitted the decision of Punjab and Haryana High Court in the case of Tribune Trust (2016) (P&H).
  • In this case the High Court decided the issue of applicability of section 2(15) in favour of Improvement Trust.

Reference by ITAT to an older case

High Court of Punjab & Haryana High Court in case of CIT(E), Chandigarh Vs. M/s Improvement Trust, Moga held that:

  • The Tribunal also rightly held that an object of general public utility did not necessarily require the activities to be funded or subsidized by the State.
  • So long as the objects fell within the ambit of the words “object of general public utility”, it was sufficient.
  • The achievements of those objects did not have to be as a result of State funding or State subsidy.
  • The Tribunal accordingly rightly held that the authorities were not justified in denying the benefit of section 11 and holding that the assessee was not covered by the words “advancement of any other object of general public utility” in Section 2(15).
  • The Tribunal, therefore, rightly directed the Assessing Officer to delete disallowance of exemption.
  • It could not possibly be suggested that the Government of Punjab formed the trusts under the Punjab Town Improvement Act, 1922 because it wanted to carry on the business as colonizers or developers under the mask of the category “objects of general public utility”.
  • Section 28(2)(iii) of the Punjab Town Improvement Act, 1922 permitted a scheme under this Act to provide inter- alia for the disposal of the land vested in or acquired by the trust including by lease, sale and exchange thereof.
  • This, however, was not the predominant activity or responsibility of the trust. Nor the assessee was making profits from this activity as its predominant motive.
  • The duty contained in Section 24 was not similar to that of a private developer or a colonizer as wrongly suggested by the Assessing Officer and confirmed by the CIT(A).
  • The development scheme under section 24 was prepared for the purpose of development of a locality.
  • Section 24(2) provided that the trust may if it is of the opinion that it is expedient and for the public advantage to promote and control the development of and to provide for the expansion of a municipality in any locality adjacent thereto within the local area of such trust prepare “an expansion scheme”.
  • The development scheme, therefore, was for the public purpose of development of any locality and an expansion scheme is also prepared when it is expedient and for the public advantage as opposed to a mere personal advantage as in the case of private developers or the colonizers.
  • The two could not possibly be compared.
  • These schemes did not contemplate mere development of the plots and the construction of the premises for sale.
  • The Trust must under the Act adopt a holistic approach for the betterment and advantage of the entire area within its jurisdiction.
  • Section 25 which provided for a housing accommodation scheme to be framed was similar.
  • The trust was required to frame such a scheme if it is of the opinion that it is expedient and for the public advantage to provide housing accommodation for any class of inhabitants within its local area.
  • The trust was, therefore, to be motivated not by personal but by public benefit. Such activities clearly fell within the last category of cases in the proviso to Section 2(15) as it stood at the relevant time, namely, “advancement of an object of general public utility”.
  • It could hardly be suggested that the Government of Punjab established the assessee’s trust and conferred upon its public responsibilities and duties of the nature specified in the PTI Act as a camouflage for its commercial, trade and business ventures. The creation and incorporation of the trust under section 3 was for a public purpose.
  • The appellants, would, therefore, undoubtedly have been entitled to the benefit of Section 10(20A).
  • The assessee would not have been entitled to the benefit of Section 10(20A) upon its omission by the Finance Act, 2002 with effect from 01.04.2003. Section 10(20A) of the Act did not contain any other requirement. It was wider than Section 2(15).
  • However, Section 2(15) and the corresponding sections including Sections 11, 12, 12A and 12AA were independent of Section 10(20A) of the Act.
  • Upon the omission of Section 10(20A), the provisions of the other sections were not affected. They remained intact.
  • An assessee could have been entitled to the provisions of Section 10(20A) and the other provisions simultaneously. The omission of one, however, did not affect the validity or the existence of the others.
  • The two provisions were distinct and independent of each other. Thus, the omission of Section 10(20A) did not affect the rights of the parties claiming the benefit of Sections 2(15), 11, 12, 12A and 12AA of the Act.

Conclusion by ITAT in the present case

Following the above judgement, ITAT did not find any infirmity in the order of the CIT(A) and deciding the identical issue in favour of the assessee the departmental appeal was dismissed.

In simple words, benefit of Sections 2(15), 11, 12, 12A and 12AA are available even on the omission of Section 10(20A).

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Can the AO change the method of share valuation which has been opted by the Assessee?

Can the AO change the method of share valuation which has been opted by the Assessee?

As per the provisions of Section 56(2)(viib) of the Income Tax Act, if a company in which public are not substantially interested, receives in any previous year, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares, if exceeds the fair Market Value of the shares shall be taxed as income from other sources.

The methods of valuation are prescribed in Rule 11UA(2) of the Rules.

According to Rule 11UA(2), 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 under clause (a) or clause (b), at the option of the assessee, namely:—

(a) the fair market value of unquoted equity shares = where, (A–L) × (PV), (PE)

A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortised amount of deferred expenditure 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, namely:

  • the paid-up capital in respect of equity shares;
  • 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;
  • reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
  • any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund 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
  • any amount representing provisions made for meeting liabilities, other than ascertained liabilities
  • any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

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

P V = the paid up value of such equity shares; or

(b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.

Let us refer to the case of I-Exceed Technology Solutions Pvt. Ltd. Vs ITO (ITAT Bangalore), where the issue under consideration was whether the AO could change the method of valuation which has been opted by the Assessee.

Facts of the Case:

  • The assessee company was engaged in the business of developing software products and providing consultancy services to customers in banking and financial services industry.
  • The AO noticed that the assessee has issued 6,15,088 equity shares of Rs.10 each at a premium of Rs. 80 per share to six persons.
  • Accordingly, it collected share premium.
  • Out of the premium amount, the AO noticed that the share premium received from resident shareholders was Rs. 1,77,77,760.
  • Accordingly, he proceeded to examine the collection of share premium in terms of sec. 56(2)(viib).
  • The assessee furnished a valuation certificate obtained from a Chartered Accountant in support of the price at which the shares were issued.
  • The AO noticed that the CA had adopted discounted cash flow method (DCF Method) for valuation of shares.
  • In the valuation report, the accountant had arrived at the value per share at Rs. 87.56 per share.
  • However, the assessee has issued shares @ Rs. 90 per share including share premium of Rs. 80 per share. Accordingly, the assessee justified the share premium collected by it.
  • The AO noticed that, under DCF method, the valuation was arrived on the basis of projected figures.
  • Further, it was noticed that the details of projected results were furnished by the management only and the basis of projections were also not given.
  • Accordingly, the AO rejected DCF method of valuation.
  • AO took the view that the share valuation has to be arrived on the basis of book value, i.e., Net Asset value (NAV) method.
  • On the basis of assets and liabilities of the assessee, the AO worked out the value of per share @ Rs. 6.04.
  • Accordingly, the AO the view the share premium collected by the assessee is not justified.
  • Since share premium amount collected from resident persons could alone be assessed u/s 56(2)(viib), the AO assessed the share premium of Rs. 1,77,77,760 as the share premium collected from resident shareholders.

Order of Commissioner of Income Tax (Appeals) [CIT(A)]

  • The CIT(A), in principle, agreed with the view taken by the AO.
  • However, he noticed that the share premium received from resident shareholders was Rs.88,88,880 only and not Rs. 1,77,77,760 as assessed by the AO.
  • Accordingly, he confirmed the addition to the extent of Rs. 88,88,880.
  • Aggrieved, the assessee has filed an appeal before Income Tax Appellate Tribunal (ITAT)

Observations of ITAT on contention of AO

  • The law contemplated invoking provisions of section 56(2)(viib) of the Act only in situations where the shares are issued at a premium and at a value higher than the fair market value.
  • The fair market value contemplated in the provisions above shall be the value
    1. As may be determined in accordance with such method as may be prescribed; or
    2. Any other value to the satisfaction of the Assessing Officer
  • The law provides that, the fair market value may be determined with such method as may be prescribed or the fair market value can be determined to the satisfaction of the AO.
  • The provision provides an Assessee two choices of adopting either NAV method or DCF method.
  • If the Assessee determines the fair market value in a method as prescribed, the AO did not have a choice to dispute the justification.
  • The provisions of Rule 11UA(2)(b) of the Rules provides that, the Assessee can adopt the fair market value as per the above two methods and the choice of method is that of the Assessee.
  • ITAT took the view that the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the Assessee but the basis has to be DCF method and he cannot change the method of valuation which was opted by the Assessee. 
  • ITAT was of the view that, the AO had erred in considering the actuals of revenue and profits declared in the future years as a basis to dispute the projections.
  • At the time of valuing the shares, the actual results of the later years would not be available.
  • What was required for arriving at the fair market value by following the DCF method were the expected and projected revenues.
  • Accordingly, the valuation was on the basis of estimates of future income contemplated at the point of time when the valuation was made.
  • It was clarified by the Assessee that the product which was being developed by the Assessee had substantial value and the Assessee was able to raise funds to the tune of Rs. 50.13 crores from international market

Reference by SC to an older case

SC was of view that the issue with regard to valuation had to be decided afresh by the AO on the lines indicated in the decision of ITAT, Bangalore in the case of VBHC Value Homes Pvt.Ltd., Vs ITO (supra) i.e.,

  • the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee.
  • For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual result of future cannot be a basis to decide about reliability of the projections. The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method. Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, Scientific study and applicable Guidelines regarding DCF Method of Valuation.

The order of CIT(A) was accordingly set aside for deciding the issue afresh after due opportunity of hearing to the Assessee.

In simple words, AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the Assessee but he cannot change the method of valuation which has been opted by the Assessee.

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