BUDGET PROPOSAL IN RELATION TO AMENDMENT OF SECTION 56 OF THE INCOME TAX ACT 1961 VIDE FINANCE BILL 2012.

[C.A. DEV KUMAR KOTHARI]

Clause 21 of the Bill concerns proposals to amend section 56. The clause reads as follows (with highlights added by author in respect of real changes):

Amendment of section 56.

     21. In section 56 of the Income-tax Act, in sub-section (2),—

      (A) in clause (vii), in the Explanation, for clause (e), the following clause shall be substituted and shall be deemed to have been substituted with effect from the 1st day of October, 2009, namely:—

      ‘(e) “relative” means,—

           (i) in case of an individual—

                (A) spouse of the individual;

                (B) brother or sister of the individual;

                (C) brother or sister of the spouse of the individual;

                (D) brother or sister of either of the parents of the individual;

                (E) any lineal ascendant or descendant of the individual;

                (F) any lineal ascendant or descendant of the spouse of the individual;

                (G) spouse of the person referred to in items (B) to (F); and

           (ii) in case of a Hindu undivided family, any member thereof;’;

      (B) after clause (viia), the following shall be inserted with effect from the 1st day of April, 2013, namely:—

           ‘(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:

          Provided that this clause shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.

               Explanation.—For the purposes of this clause,—

      (a) the fair market value of the shares shall be the value—

           (i) as may be determined in accordance with such method as may be prescribed; or

           (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;

      (b) “venture capital company”, “venture capital fund” and “venture capital undertaking” shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation 1 to clause (23FB) of section 10;’.

Analysis and comments:

Relative of individual:

We find that there is no change in meaning in relation to individual; the meaning is same as it is now applicable. There are doubts as to whether a gift received from HUF by a member is covered by exemption or not. Some benches of Tribunal has held that gift received by a member from HUF is gift received from a relative ( relative considered  in a collective manner because all members are relatives of each other).

This aspect has  not  been clarified. The meanings given for relative are not based on reciprocity. Therefore, it is desirable to include HUF also in definition of relative in relation to an individual

Relative on HUF:

At present there is no meaning given for a relative of HUF. HUF consists of members who are relative in natural way as well as per meaning of relative given in context of individual. Therefore, all members of HUF can be considered as relative of HUF. Some Tribunals have taken such a view.

In case of HUF it is prescribed that any member of HUF will be considered as relative of HUF. This is an amendment which was necessary for clarification.

 Under the existing provisions of clause (vii) of sub-section (2) of section 56 any sum or property received by an individual or HUF for inadequate consideration or without consideration is deemed as income and is taxed under the head “Income from other sources”. However, in the case of an individual, receipts from relatives are excluded from the purview of this section and are therefore treated as not taxable. The definition of relative as given in this sub-clause is only in relation to an individual and not in relation to a HUF. It is therefore proposed to amend the provisions of section 56 so as to provide that any sum or property received without consideration or inadequate consideration by an HUF from its members would also be excluded from taxation.

Therefore, after this amendment a member can gift property to HUF without attracting tax and without doubt.

Issue of shares at a premium by closely held Companies may attract tax on element of premium:

New clause in section 56(2) if enacted will make it difficult to issue shares at premium by closely held companies when shares are issued to a resident at premium.

 The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income tax under the head “Income from other sources.

 

Exceptions:

This provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital  company or a venture capital fund.

Where  the company can substantiate its claim regarding the fair market value.

It is proposed that the fair market value of the shares shall be the higher of the value— (i) as may be determined in accordance with the method as may be prescribed; or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

 There should not be restriction on premium:

In case of closely held companies promoters and their associates issue shares at premium with a view to have low capital base in terms of number of shares issued yet raising capital required by company. This helps in improving capital base, better book value of shares, higher earnings per share, and chances of declaring higher dividend on paid-up capital and possibility of issue of shares by way of bonus shares out of premium at appropriate time.

The decision to issue shares by company and to subscribe shares by shareholder is a voluntary decision of both parties. We find that even in cases of companies whose accumulated losses exceeds paid-up share capital have substantial price. Even loss making companies can issue shares at premium.

One of the reason for issuing shares at premium is  to keep cost of  capital low by restricting dividend, and also by saving on account of authorized capital fees payable to the Registrar of Companies, which is now-a-days substantial amount.

In this case exception should also be provided for shares issued to promoters and their associates.

Share premium  received is a capital receipt and cannot be deemed as income, the provision will therefore, be beyond the power to tax income.