2025 (4) TMI 1357 - AT - Income Tax

Applicability of section 56(2)(viib) - issue of shares at premium to parent company - AO observed that assessee declared losses and its future prospects are not promising however it has charged huge premium on the shares issued - HELD THAT - As assessee M/s EPEL is wholly owned subsidiary of M/s ESL. Since EPEL is a 100% subsidiary of ESL (a listed company) EPEL is also a company in which public are substantially interested within the meaning of Section 2(18)(b)(B)(c) of the Act. Accordingly the provisions of Section 56(2)(viib) of the Act which are applicable to the unquoted equity shares of a company in which public is not substantially interested are not applicable to the case of EPEL where the shares are issued at premium. By respectfully following the decision of case of Appollo Sugar Clinic 2019 (6) TMI 340 - ITAT HYDERABAD we find no infirmity in the order of ld. CIT(A) in holding that the assessee is 100% subsidiary of M/s ESL and therefore is a company in which public is substantially interested and thus the provisions of section 56(2)(viib) of the Act are not applicable. Accordingly we uphold the order of ld. CIT(A) deleting the additions made by AO. Appeal of the revenue is dismissed.

Summary

The core legal questions considered in this appeal revolve around the applicability of section 56(2)(viib) of the Income Tax Act, 1961 ("the Act") to the assessee company, which issued shares at a premium, and the correctness of the Assessing Officer's (AO) addition to income based on alleged undervaluation of share premium. Specifically, the issues are:

1. Whether the provisions of section 56(2)(viib) apply to the assessee company, given that it is a wholly owned subsidiary of a public limited company listed on recognized stock exchanges.

2. Whether the AO was justified in rejecting the Discounted Cash Flow (DCF) method valuation report submitted by the assessee and substituting it with a Net Asset Value (NAV) method valuation to determine the fair market value (FMV) of shares for the purpose of addition under section 56(2)(viib).

3. Whether the addition made by the AO on account of alleged excess share premium is sustainable in the absence of a valuation report or justification from the parent company that subscribed to the shares.

Issue-wise detailed analysis:

Issue 1: Applicability of Section 56(2)(viib) to the Assessee Company

The relevant legal framework includes section 56(2)(viib) of the Act, which taxes any consideration received by a company for the issue of shares exceeding the FMV of such shares, but only if the company is "not being a company in which the public are substantially interested." Section 2(18) of the Act defines "company in which the public are substantially interested." Sub-clause (b)(B)(c) is particularly relevant, stating that a company is substantially interested by the public if shares carrying not less than 50% of voting power are beneficially held throughout the relevant previous year by a company which itself is substantially interested or a subsidiary thereof.

The Court examined the facts that the assessee company is a closely held limited company but is 100% owned by M/s Educom Solutions Limited (ESL), a public limited company listed on BSE and NSE. The balance sheet notes confirmed the entire shareholding of the assessee was held by ESL. Thus, the assessee is a wholly owned subsidiary of a public company listed on recognized stock exchanges.

Applying the statutory definition, the Court held that the assessee company qualifies as a "company in which the public are substantially interested" under section 2(18)(b)(B)(c). Therefore, the provisions of section 56(2)(viib), which apply only to companies not substantially interested by the public, do not apply to the assessee company.

The Court relied on a coordinate bench decision in a similar case, which held that a wholly owned subsidiary of a listed public company falls within the ambit of "company in which the public are substantially interested," and thus section 56(2)(viib) is not applicable. This precedent was followed to affirm the non-applicability of section 56(2)(viib) to the assessee.

Issue 2: Validity of AO's Rejection of DCF Method and Adoption of NAV Method for Valuation

The assessee had submitted a valuation report based on the Discounted Cash Flow (DCF) method to determine the FMV of shares at the time of issue. The AO rejected this valuation report on the ground that the company was incurring losses and its future prospects were not promising. The AO instead applied the Net Asset Value (NAV) method to value the shares and arrived at a lower FMV, leading to an addition of Rs. 7.27 crores for excess share premium.

The assessee contended that section 56(2)(viib) and Rule 11UA(2) provide two methods-DCF and NAV-for determining FMV of unquoted shares, and the choice of method lies with the assessee. The AO was not entitled to arbitrarily reject the DCF method without obtaining an alternative valuation report from a specified person or without proper justification. The substitution of the valuation method by the AO was thus impermissible.

The Court noted that since section 56(2)(viib) itself does not apply to the assessee company, the question of valuation method becomes moot. However, even on merits, the AO's unilateral change of valuation method without following due procedure was not justified.

Issue 3: Justification for Addition in Absence of Valuation Report from Parent Company

The AO issued a notice under section 133(6) to the parent company ESL, which was under corporate insolvency resolution and did not furnish any valuation report or justification for the share premium. The AO proceeded to make additions based on his own valuation.

The assessee argued that since ESL was under insolvency resolution and had no valuation report, no addition could be sustained. The Court observed that the absence of valuation or justification from ESL was not sufficient to override the statutory exemption under section 56(2)(viib) given the assessee's status as a wholly owned subsidiary of a public company. The AO's addition was thus not sustainable.

Conclusions on Issues

The Court concluded that the provisions of section 56(2)(viib) are not applicable to the assessee company because it is a wholly owned subsidiary of a public limited company listed on recognized stock exchanges, thereby qualifying as a "company in which the public are substantially interested" under section 2(18)(b)(B)(c). Consequently, the addition made by the AO on account of alleged excess share premium was rightly deleted by the Commissioner of Income Tax (Appeals) [CIT(A)].

The Court further upheld that the AO's rejection of the DCF method and adoption of NAV method without following due process was improper, but this issue was rendered academic due to the non-applicability of section 56(2)(viib) itself.

Significant holdings include the following verbatim excerpt from the judgment:

"Since EPEL is a 100% subsidiary of ESL (a listed company), EPEL is also a company in which public are substantially interested within the meaning of Section 2(18)(b)(B)(c) of the Act. Accordingly, the provisions of Section 56(2)(viib) of the Act which are applicable to the unquoted equity shares of a company in which public is not substantially interested are not applicable to the case of EPEL where the shares are issued at premium."

And from the coordinate bench decision cited:

"In the given case, the fact is clear that assessee has received share premium and Assessing Officer has mandate to invoke only Section 56(2)(viib) and no other section. This transaction will never fall in any of the heads of income as per Section 14 of the Act. Therefore, in our considered view, Assessing Officer is not correct in bringing this capital investment as income of the assessee after satisfying himself that assessee's case does not fall u/s. 56(2)(viib) of the Act. Therefore, the addition made by Assessing Officer is deleted."

The core principle established is that the anti-abuse provisions of section 56(2)(viib) do not apply to companies substantially interested by the public as defined in section 2(18), and the mere issuance of shares at premium by a wholly owned subsidiary of a listed public company does not attract taxation under this provision.

Accordingly, the final determination was to dismiss the revenue's appeal and uphold the deletion of the addition made by the AO, confirming that the premium received on shares issued by the assessee company is not taxable under section 56(2)(viib) of the Act.