No Tax on Closely Held Companies, if Excess Share Premium Paid by Relatives-Shareholders

The assessee-company had only two shareholders ‘S’ and her husband. On passing away of husband, his shares devolved on their daughter ‘V’. The assessee proposed to acquire an immovable property at approximately Rs. 23.09 crores. ‘S’ brought in money into the company by allotment of fresh 10,100 shares with a share premium of Rs. 23.31 crores.
The AO opined that company had received excess share premium for the shares allotted to ‘S’ above the face value of shares. Accordingly, AO brought Rs. 23.31 crores to tax in the hands of the company u/s 56(2) (viib).

Assessee stated that the purpose u/s 56(2) (viib) is to tax undue benefit given to the existing shareholders by way of introducing large amount of share premium.
However, in instant case benefit went to daughter of the shareholders, who fell within the exempted category of relatives under section 56(2)(x). Hence, any benefit granted by mother to daughter is not taxable u/s 56(2)(x).
Moreover, the beneficial transfer from one shareholder to the other shareholder was only 25% of the shareholding and, as such, the taxation of share premium should also be restricted to only 25% of the total premium received u/s 56(2) (viib).

The Revenue stated that Section 56(2) (viib) section has not provided for limiting the amounts attracted (viib) for taxation by considering the benefit which accrues to the existing set of shareholders on account of share allotment to new set of shareholders
Moreover, assessee had not claimed any such futuristic method of valuation, like the discounted cash flow or any other such methods prescribed under Rule 11UA.
Therefore, AO had taken the valuation at NAV and considered the entire share premium as being excessive and liable for taxation u/s. 56(2) (viib).

The ITAT held its judgement in favour of assessee stating that provisions of section 56(2) (viib) couldn’t be invoked in the case of the assessee-co. because, by virtue of introducing cash in the company by for allotment of equity shares with unrealistic premium, the benefit had only passed on to her daughter.
Based on facts and clarifications, it can be said that by the virtue of provisions of sections 56(2)(vi) and 56(2)(x) when gift is bestowed by mother to daughter, it is not taxable and therefore, where there are transactions involving family arrangement with respect to transfer of shares, corporate veil is required to be lifted for the benefit of assessee as well to identify the substance over form.

Source: [2018] 98 taxmann.com 92 (Chennai – Trib.)

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