BACKGROUND

Section 56(2)(viib) was introduced in the Income-tax Act,1961 (IT Act) by the Finance Act, 2012 to tax consideration received in excess of the Fair Market value (FMV) of shares by a closely held company. This provision was applicable to shares issued to resident investor(s) only. However, with effect from 1 April 2023, the Finance Act, 2023 extended the applicability of this section to non-resident investor(s) as well.

For computing FMV of shares, Rule 11UA of the Income-tax Rules, 1962 (IT Rules) was introduced and has undergone amendments. The latest amendment was by Notification No. 81/2023 dated 25 September 2023 wherein it introduced an additional valuation method as well as safe harbour provision (i.e. if the difference between actual consideration and FMV does not exceed 10%, then the actual consideration shall be deemed to be the FMV. Please click here to read our alert. This Rule is effective from 25 September 2023.

Since the amended Rule 11UA is effective from 25 September 2023, a question may arise as to its applicability to the period 1 April 2023 to 25 September 2023. In this regard, recently, while dealing with a matter where the difference between the FMV and consideration was less than 10%, the Delhi Tax Tribunal¹ had an occasion to analyse the applicability of the safe harbour provision contained in Rule 11UA of the IT Rules.

We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

• During Fiscal Year (FY) 2014-15, the taxpayer, a private limited company, issued equity shares at INR 15 per share at a premium of INR 5. In terms of Rule 11UA of the IT Rules, the taxpayer obtained a valuation report from a Chartered Accountant wherein the shares’ value was determined at INR 14.77 per share.

• The tax officer computed the FMV at INR 14.68 per share and thereby brought the differential amount [i.e. 1,58,66,670 shares *(15-14.68)] to tax in the hands of the taxpayer. The difference between the value adopted by the taxpayer and the value computed by the tax officer is 2%.

• The first appellate authority confirmed the additions made by the tax officer.

• Aggrieved, the taxpayer filed an appeal before the Delhi Tax Tribunal. Before the Delhi Tax Tribunal, the taxpayer took an additional ground wherein it relied on Notification No. 81/2023 and contended that as the difference is less than 10%, no addition under section 56(2)(viib) of the IT Act is warranted.

DELHI TAX TRIBUNAL RULING

The Delhi Tax Tribunal held that the curative amendment in Rule 11UA of the IT Rules introduced by the Notification 81/2023 will apply retrospectively and since the difference was less than 10%, deleted the addition made by the Tax Officer. While coming to this conclusion, the Delhi Tax Tribunal made the following observations:

• The difference between the value adopted by the taxpayer and the value computed by the tax officer is minuscule, which makes it evident that no addition is warranted under section 56(2)(viib) of the IT Act.

• Reliance placed by the taxpayer on Chennai Tax Tribunal ruling in M/s Jain Housing² wherein the addition made under section 56(2)(viib) was deleted as the difference between the FMV and the value adopted by the tax officer was less than 1%.

• On additional ground raised, keeping in view, the judgment of the Hon’ble Apex Court in the case of National Thermal Power Co. Ltd. Vs CIT³, the additional ground filed by the taxpayer is accepted.

• As per CBDT Notification 81/2023 dated 25 September 2023⁴, where the difference between the issue price and the value adopted by the tax officer is 10% or less, the issue price will be deemed to be the FMV of shares for the purpose of Rule 11UA of the IT Rules.

• In the present matter, the difference between the issue price and value adopted by the tax officer is INR 0.32 i.e. 2.21% (0.32/15) which is less than the safe harbor of 10% variation.

• With regard to the applicability of Notification 81/2023, as it is a curative amendment and the same will be applicable retrospectively, we find that the Hon’ble Apex Court in Allied Motors Private Limited⁵ has observed that where a proviso which is inserted to remedy unintended consequences and to make the provision workable, a proviso which supplies an obvious omission in the section and is required to be read into the section to give the section a reasonable interpretation, requires to be treated as retrospective in operation, so that a reasonable interpretation can be given to the section as a whole.

• Reliance was also placed on Mumbai Tax Tribunal’s ruling in case of Shaista Irphan Mogul⁶ wherein it was held that the amendment (i.e. introduction of tolerance limit of 10%) was intended to cure hardship and will have a retrospective application.

• The amendment brought in Rule 11UA of the IT Rules was introduced to mitigate the hardship faced by taxpayers by the unintended invocation of Section 56(2)(viib) of the IT Act read with Rule 11UA of the IT Rules and therefore the same is a curative amendment.

• Hence, in view of the above, curative amendment in Rule 11UA of the IT Rules introduced by CBDT Notification 81/2023 will apply retrospectively.

BDO IN INDIA COMMENTS

This is a welcome ruling as it clarifies that the amendment by Notification No. 81/2023 is curative in nature and thereby applicable retrospectively. It is imperative to note that this decision pertains to FY 2014-15 and the Tax Tribunal has held that the safe harbour rate of 10% is applicable to that year as well. Thus, this Ruling will be helpful for all the pending matters (for shares issued before 25 September 2023) where the difference between the FMV and issue price is less than 10%. Further, the taxpayer(s) who have issued shares to non-resident investor(s) between 1 April 2023 and 25 September 2023 may evaluate the impact of this Ruling on the share valuation method adopted by them vis-à-vis prescribed in Notification No. 81/2023.