2025 (5) TMI 431 - AT - Income Tax

Addition u/s. 56(2)(vii)(c)(ii) - difference in the valuation of shares calculated as per rule 11(UA) as compared to the valuation given in the valuation report obtained from independent valuer - HELD THAT - Assessee has demonstrated that it is not a case of allotment of shares of higher value at lower rates with a purpose of transferring capital asset of higher value for less money. In fact the company Baroque Pharmaceutical Ltd. had obtained loan of Rs. 22 crores for its business needs from the bank and to comply the conditions of the loan sanction letter the outstanding loan of Rs. 10, 39, 000/- given by the assessee was converted into share capital. Even the ld. counsel has also demonstrated various discrepancies in the valuation done by the AO. In view of this find no justification on the part of the AO to make impugned additions and the same are ordered to be deleted. Appeal of the assessee stands allowed.

Summary

The core legal question considered in this appeal is whether the Assessing Officer was justified in making an addition under section 56(2)(vii)(c)(ii) of the Income Tax Act read with Rule 11UA of the Income Tax Rules on account of difference in valuation of shares allotted to the assessee upon conversion of unsecured loans into share capital by the company.

The principal issue revolves around the valuation of shares allotted by Baroque Pharmaceutical Ltd. to the assessee against conversion of unsecured loans amounting to Rs. 10,39,000/-. The Assessing Officer applied Rule 11UA to value these shares at Rs. 1706/- per share, whereas the assessee relied on a valuation report from an independent valuer, which valued the shares at Rs. 1000/- per share. Consequently, the Assessing Officer made an addition of Rs. 7,33,534/- under section 56(2)(vii)(c)(ii) for the difference in valuation.

Further, the validity of the return filed by the assessee was also indirectly challenged, as the Assessing Officer passed the order under section 147 read with section 144 of the Act, rejecting the return as invalid. The CIT(A) upheld the addition through an ex-parte order.

Regarding the valuation issue, the relevant legal framework includes section 56(2)(vii)(c)(ii) of the Income Tax Act, which deals with income arising from receipt of shares without consideration or at a value less than fair market value, and Rule 11UA of the Income Tax Rules, which prescribes the method for valuation of unquoted shares for the purposes of the Act. The Assessing Officer's reliance on Rule 11UA valuation was challenged by the assessee on grounds of discrepancies in the computation, including failure to consider book value of assets, tax credits (TDS/TCS/advance tax), and unamortized expenditure.

The Court's interpretation emphasized that the conversion of unsecured loans into share capital was not a mechanism to transfer capital assets of higher value at lower rates, but a business-driven necessity. The company had obtained a substantial loan of Rs. 22 crores from a bank, which stipulated as a condition that unsecured loans from private parties be converted into share capital. This contextual business rationale was accepted as a legitimate commercial arrangement rather than a tax avoidance scheme.

Key evidence included the loan agreement condition from the bank, the valuation report from the independent valuer, and the discrepancies highlighted by the assessee's counsel in the Assessing Officer's valuation computation. The Court found that the Assessing Officer's valuation was flawed due to ignoring crucial elements such as book value adjustments and tax credits, which materially affected the fair value of shares.

Applying the law to the facts, the Court held that the addition under section 56(2)(vii)(c)(ii) was unwarranted because the valuation adopted by the Assessing Officer was not reflective of the true fair market value of the shares. The Court recognized the bona fide business need for conversion of loans into equity as a condition for bank financing and rejected the notion that the transaction was intended to confer an undue benefit or to pass on shares at artificially low prices.

In addressing competing arguments, the Court gave due weight to the assessee's detailed submissions on valuation discrepancies and the business context, while noting the Department's reliance on statutory valuation rules and lower authorities' findings. The Court found the Department's approach to be mechanical and lacking appreciation of the commercial realities and valuation nuances.

Consequently, the Court concluded that the Assessing Officer's addition was unjustified and ordered deletion of the impugned addition, thereby allowing the appeal.

Significant holdings include the Court's recognition that valuation under Rule 11UA must be applied with due consideration of all relevant financial parameters, including book value and tax credits, and not in a mechanical manner. The Court underscored that conversion of unsecured loans into shares pursuant to bona fide business conditions imposed by a bank does not ipso facto attract addition under section 56(2)(vii)(c)(ii) if the valuation is fair and substantiated.

In the Court's words: "I do not find justification on the part of the Assessing Officer to make impugned additions and the same are ordered to be deleted." This statement encapsulates the core principle that valuation for tax purposes must reflect commercial substance and accurate computation rather than rigid application of formulae.

Final determinations on the issues are as follows: the addition under section 56(2)(vii)(c)(ii) on account of difference in share valuation was not sustainable; the return filed by the assessee could not be rejected on the basis of the valuation dispute; and the appeal was allowed with deletion of the addition.