2025 (6) TMI 159 - AT - Income Tax

Addition on account of provisions of section 56(2)(vii)(c) - assessee has acquired shares for a consideration which is less than aggregate fair market value of the shares - AO rejected assessee s contention and adopted value of shares on which they were traded in the stock exchange and thus made addition - CIT(A) deleted addition - HELD THAT - We find that nowhere it is emanating from the assessment order or the order of CIT(A) the period of lock-in of shares purchased by the assessee. The shares were sold by Sri Kalanithi Maran to the assessee in pursuance of Shares Sales and Purchase Agreement dated 21.01.2015. The convents of the said agreement are nowhere discussed in the orders of the authorities below. The class of shares purchased by the assessee i.e. the share purchased by assessee are also listed on stock exchange is also not emanating from the impugned order. Mere fact that the shares are in lock-in is not sufficient to come to the conclusion that the market value shall be determined in a manner similar to that of unquoted shares i.e. in accordance with Rule 11UA. AO shall also examine the relevance and impact of issuance of 189091378 convertible warrants having nominal value of Rs. 10 each at a premium of Rs. 6.30 per share to the outgoing promoter. Considering the above shortcomings in the orders of the authorities below we deem it appropriate to restore this issue back to the AO for denovo assessment. Appeal of Revenue is allowed for statistical purpose.

Summary

The core legal questions considered in this appeal relate to the valuation of shares for the purpose of income computation under section 56(2)(vii)(c) of the Income Tax Act, 1961. Specifically, the issues are:

1. Whether the Assessing Officer (AO) was justified in adding Rs. 7,98,97,75,682/- to the assessee's income on account of undervaluation of shares acquired at a consideration less than their aggregate fair market value (FMV) as per section 56(2)(vii)(c).

2. Whether the AO erred in applying the FMV based on the quoted price of the shares on the stock exchange, ignoring the lock-in status of the shares and the valuation principles applicable to locked-in or unquoted shares under Rule 11UA(1)(c)(a) of the Income Tax Rules.

3. Whether once a company is listed, all its shares, including those held by promoters and subject to lock-in, must be treated as quoted shares for valuation purposes.

4. Whether the CIT(A) failed to consider that a substantial portion of shares purchased were encumbered with banks, which affects their valuation and negates the proposition that their value could be nil or negative.

These issues collectively address the correct method of valuation of shares for tax purposes when shares are acquired at a price significantly lower than their market value and are subject to lock-in and encumbrances.

Issue 1 & 2: Legality of Addition under Section 56(2)(vii)(c) and Valuation Methodology for Locked-in Shares

The legal framework governing the valuation of shares acquired for less than their FMV is found in section 56(2)(vii)(c) of the Income Tax Act, which mandates that the difference between FMV and consideration paid be treated as income. The FMV for quoted shares is generally determined under Rule 11UA(1)(c)(a) by reference to the lowest price on the stock exchange on the date of acquisition. However, for unquoted shares or shares under lock-in, Rule 11UA(1)(c)(b) prescribes valuation based on net asset value or other accepted valuation methods.

The AO relied on the quoted price of Rs. 22.88 per share on the Bombay Stock Exchange (BSE) as the FMV, resulting in a substantial addition to income. The AO rejected the assessee's contention that the shares were under lock-in and hence should be valued as unquoted shares, leading to a negative valuation based on a report from the company's auditors.

The assessee argued that the shares were locked-in under SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009, and thus not freely tradable on the stock exchange. Consequently, they contended that the shares should be valued as unquoted shares under Rule 11UA(1)(c)(b), supported by a valuation report indicating a negative net worth and negative share value.

The CIT(A) accepted the assessee's submissions and deleted the addition, holding that locked-in shares are akin to unquoted shares for valuation purposes.

However, the Tribunal observed that neither the AO nor the CIT(A) had examined the duration and terms of the lock-in period, nor the specific covenants of the Share Sale and Purchase Agreement dated 21.01.2015. The Tribunal emphasized that mere lock-in status does not automatically classify shares as unquoted for valuation under the Act. The Tribunal noted the absence of detailed findings on the nature of the shares, their class, and the lock-in terms in the impugned orders.

The Tribunal further noted that the AO should consider the impact of a scheme of reconstruction and the issuance of convertible warrants to the outgoing promoters, which could affect the valuation of shares. This scheme, approved shortly after the share purchase, involved issuance of warrants at a premium, indicating a valuation context that the AO had not factored in.

Given these gaps, the Tribunal held that the matter required a fresh examination by the AO, with due opportunity to the assessee to make submissions, and accordingly restored the issue for de novo assessment.

Issue 3: Treatment of Locked-in Shares of a Listed Company as Quoted Shares

The Revenue contended that since Spicejet Ltd. is a public listed company, all its shares, including those held by promoters and subject to lock-in, must be treated as quoted shares for valuation. The Revenue argued that promoters have the right to offload shares on the stock exchange subject to regulatory conditions, and therefore the FMV should be based on quoted prices.

The Tribunal recognized this argument but also highlighted that the lock-in restrictions imposed under SEBI regulations limit the free transferability of shares, which is a key factor in determining whether shares are to be valued as quoted or unquoted. The Tribunal found that the orders below did not sufficiently analyze this regulatory context or the specific lock-in terms. Hence, the Tribunal refrained from conclusively deciding this issue and directed the AO to reassess the matter considering the lock-in status and applicable regulations.

Issue 4 & 5: Valuation of Encumbered Shares

The Revenue pointed out that out of the total shares purchased from M/s Kal Airways Pvt. Ltd., 83,057,932 shares were encumbered with Allahabad Bank and Yes Bank. The Revenue argued that valuation of encumbered shares cannot be nil or negative, as the banks would not have accepted encumbrance on valueless shares.

The Tribunal noted that the impugned orders did not address the issue of encumbrance or its impact on valuation. It held that the AO should consider the encumbrance status in the fresh assessment, as it is a relevant factor affecting the FMV of shares.

Significant Holdings and Legal Reasoning

The Tribunal held that the valuation of shares under section 56(2)(vii)(c) must be determined based on a comprehensive analysis of facts, including:

• The lock-in status and its duration as per SEBI regulations;
• The nature of shares (quoted or unquoted) and the applicability of Rule 11UA;
• The impact of corporate restructuring and issuance of convertible warrants on valuation;
• The encumbrance of shares and its effect on marketability and value;
• The terms of the Share Sale and Purchase Agreement, including any restrictions on transfer.

The Tribunal emphasized that "mere fact that the shares are in lock-in is not sufficient to come to the conclusion that the market value shall be determined in a manner similar to that of unquoted shares i.e. in accordance with Rule 11UA."

It also stated that the AO must examine the relevance and impact of the issuance of convertible warrants to the outgoing promoter, given the timing and terms of such issuance.

Due to the absence of detailed findings and incomplete consideration of relevant factors by the authorities below, the Tribunal restored the matter to the AO for fresh adjudication, with a direction to provide the assessee reasonable opportunity to present evidence and submissions.

The Tribunal's final determination was to allow the Revenue's appeal for statistical purposes and remit the issue for de novo assessment, underscoring the need for a factually and legally sound valuation process consistent with the statutory provisions and applicable regulations.