Share premium- some issues with reference to section 56(2) (viib)

[CA DEV KUMAR KOTHARI]

Section 2(24)(x), 56, 68 of the Income-tax Act, 1961 and Rules 11U and 11UA of the Income-tax Rules,1962.

Green Infra Ltd. Versus Income-tax Officer 2013 (12) TMI 949 - ITAT MUMBAI

Share premium is a capital receipt:

Share premium is a capital receipt. As per provisions of law governing companies and accounting and disclosures by companies, share premium or security premium is considered a capital receipt, has to be shown in Reserves and Surplus as an item on liabilities side of balance sheet and these reserves can be used only in a limited manner permitted by the law. The permitted use of such reserves generally result into increase in share capital or reduction of some specified liabilities on capital account. Therefore, use of securities premium is also to strengthen / rather to say keep the strength of financial structure undiluted. The amount standing in securities premium is either converted into capital or reduces liabilities.

Therefore, securities premium cannot be considered revenue at any stage like at the time of receipt or at the time of use.

Share premium is generally considered as capital receipt under Income-tax Act, 1961:

Till assessment year 2012-13 share premium received by any company was not deemed as income. Even from AY 2013-14 share premium received by a listed company and some other specified companies is not deemed as income. Deeming provision as per Section 56 (viib) (inserted w.e.f. 01.04.2013) is applicable only in case of shares issued at premium by closely held companies (subject to some exceptions). And this is not applicable to a company which is listed on a recognized stock exchange and some other companies, which are also considered as company in which public is substantially interested. In case of issue of shares at premium by listed companies, share premium is not considered as income. However, in case of un-listed companies premium can be considered as income in case the price charged at the time of issue of share is more than face value (that is at premium) and is also higher than fair market value. In such case , excess of issue price above the fair market value will be considered as income of issuing price.

In case a company issues shares at face value, though market value is lower than face value, the difference between price charged that is issue price and fair market value will not be consider as income. For examples:

Issue at face value:

Fair market value is Rs.3/- due to erosion of capital by past losses.

Issue price per share of Rs. 10/- is Rs. 10/- that is at face value.

In this case excess of issue price above fair market value that is Rs.7/- per share will not be considered income because issue is at face value of Rs.10/-.

Issue at premium:

Fair market value of share of Rs.10/- is   Rs.3/- due to erosion of capital by past losses.

Issue price per share of Rs. 10/- is Rs. 15/- that is at a premium of Rs.5/- per share.

In this case excess of issue price above fair market value that is Rs.12/- per share will be considered as income of company. In this case two conditions (a) issue price in excess of face value and (b) also in excess of fair market value are satisfied.

In this case although Rs.10/-are received and credited towards share capital and Rs.5/- per share towards share premium, still Rs.12/- per share will be considered as income although premium was only Rs.10/- per share.

This shows some anomaly in provisions.

Therefore, as per provisions of tax on income also share premium is principally regarded as a capital receipt. However an attempt has been made by the government to bring into tax net share premium received by closely held companies. This is due to suspicion that in form of share capital and premium, company (or its promoters introduces their undisclosed income popularly called black money)

Regarding issue of shares at par and at premium:

Issue price of share including share premium is a subject matter of financial planning and negotiation between company and its share holders.

Shares are issued at premium with a view to strengthen capital base keeping share capital low so that servicing of share capital (by paying dividend and issue of free shares/s bonus shares) is easy and better in future.

One important aspect about share premium about dividend can be illustrated with example of shares, market price of share and dividend yield.

A share of Rs.5/- face and paid-up value is traded at a price of say Rs.3000/- company declare 200% dividend. The dividend per share of Rs.5/- is thus Rs.10/- The yield by way of dividend is 10 /3000 x 100 = 0.3333% .

In this case a person buying share at Rs.3000/- is ready to pay 2995/- per share over and above the face value. Therefore, this factor is relevant when the company decide to issue further shares and the amount of premium at which shares can be issued.

Reasons of closely held companies issuing shares at premium:

In case of many closely held companies and even in new companies promoters used to issue share at premium with the main purpose of keeping share capital low, yet capital base stronger so that break-up value and market value is high. This leads to advantage of low cost of servicing share capital and also improved prospects to issue share at premium in future by way of initial issue of offering by promoters. One more practical advantage was to save on account of cost of fees payable on increase of authorized capital. When shares are issued at premium, number of shares and authorized capital increase lesser in comparison of capital raised by way of capital and premium. For example, by increasing authorized share capital by Rs. one crore, company can raise capital + reserves of say Rs.500 crore if a share of Re.1/- per share is issued at a premium of Rs.499 per share. In such a case, company would pay fees of authorized capital for Rs. one crore, yet company can raise total capital including reserves Rs.500 crore.

In such situation dividend will be payable on Rs. one crore although Rs.500 crore have been raised. As an when company feel financially comfortable, it can pay dividend at higher rate. Furthermore, as and when company find itself in a position to issue bonus shares, it can issue bonus shares on strength of share premium.

Share premium and deemed income:

As observed earlier also, section 56 (viib) is applicable only in case of shares of a company which is not listed on a recognized stock exchange. In case of issue of shares at premium by listed companies, share premium is not considered as income. However, in case of un-listed companies premium (even a part of capital in case of loss making company) can be considered as income in case the issue price is higher than fair market value of unlisted share or shares of closely held companies.

Rule 11U, and 11UA- valuation of shares:

Rule 11U provides meaning of some relevant words in relation to valuation of assets and Rule 11UA provide method of valuation of various assets for ascertaining taxable amount. The valuation of shares of closely held companies for the purposes of S. 56 can be made only by a FCA (Fellow Chartered Accountant – not necessary to be in practice), who is not statutory auditor under section 224 of the Companies Act, 1956 and who is not tax auditor u/s 44AB of the Income-tax Act as per Rule 11U (1), relevant balance sheet will be as per meaning U/r 11U (b) read with meaning of ‘valuation date’ as per Rule 11U (j). Valuation can also be made by a merchant banker as defined in Rule 11U (c) if valuation is made under the Discounted free cash flow method.

One simple illustration:

 A company has capital and premium as follows:

Share capital issued to promoters    Re. 1 per share                     100K

Share premium on above                                                            900K - (this or part of it may be taxable, if Breakup value is less than Re1/- on the date of issue)

Net worth                                                                                   1000K

 The net worth is represented fully by net realizable assets of company.               1000K

There is no liability.

Fair value per share of Re. 1/- is thus  (A-L)/ PE X PV

=   (1000 – 0) /100 x 1 = 10

This is to be considered for pricing of further issue of shares.

Therefore, now company can issue further shares at premium of say Rs.9/- per share without attracting S. 56 (viib)  read with Rule 11U and 11UA. In case company issues shares at Rs.15/- than Rs.5/- per share may be treated income of company as it is in excess of fair market value.              

Share capital issued to promoters  Re. 1 per share 100 shares Rs.   100

Share premium on above  @ Rs.99/- per share  Rs. 9900

The above premium of Rs.9900 may be taxable u/s 56(2)(viib)

 The net worth is represented fully by net realizable assets of company  Rs.10000

There is no liability.

Fair value per share of Re. 1/- is thus  (A-L)/ PE X PV

=   (10000 – 0) /100 x 1 = 100/-

Thus Rs.100/- per share of Rs. 1/- per share is to be considered for pricing of further issue of shares.

Therefore, now company can issue further shares at premium up to Rs.99/- per share without attracting S. 56 (2) (viib)  read with Rule 11U and 11UA. In case company issues shares at price ranging between 1.01 (premium 1paisa per share to maximum Rs.100/- per share (premium Rs.99/- per share) there will be no income taxable u/s 56 (2) (viib).

If the company issues further shares at Rs.100/- per share, the net worth or fair market value per share shall be maintained at Rs.100/- If premium in excess of Rs. 99/- per share is charged, then fair market value post issue will improve. If premium on further issue of shares is charged less than Rs.99/- per share, then fair market value per share on post issue of capital will decline.

Provisions of S.68:

As per provisions of section 68, any unexplained credit found in books of account of assessee can be considered as income, if the assessee cannot satisfactorily explain the nature and source of receipt of sum represented by credit. Therefore, share capital and share premium both can also be considered as income, if the assessee is unable to establish identity and existence of share holders who contributed share capital and premium. In case the share holder has not disclosed or accounted for his investment, then he can be taxed by way of including undisclosed/ unaccounted for investments in his income.

However, in hands of company share capital may not, generally be taxable, because share holders are publicly recognized as shareholder of company and such shares are transferable by the shareholder.

Therefore, we find that in case money received against share capital is not substantiated then even share capital can be considered as income u/s 68 if in fact company has introduced its own undisclosed income as share capital. That provision imposes tax on income.

However, section 56(2) (viib) presumes even capital receipt as income which may not be within the power of the Central Government which is restricted to imposition of tax on income. Readers may refer to article titled “Section 56 deeming gifts as income appears to be ultravirse the Constitution of India (COI) , not within scope of “tax on income” and purposes and charging provisions of the Income-Tax Act (ITA). “ written by author and webhosted on this website.

Judgment of Tribunal on issue of shares at premium and taxability u/s 68:

In Green Infra Ltd. Versus Income-tax Officer 2013 (12) TMI 949 - ITAT MUMBAI question arose about application of section 68 when company issued share of rs.10/- at a premium of Rs.490/- per share. The share holders were found genuine , existing and who have verified investment made by them.

The Tribunal observed that no doubt a non-est company or a zero balance company asking for a share premium of Rs. 490/- per share defies all commercial prudence but at the same time we cannot ignore the fact that it is a prerogative of the Board of Directors of a company to decide the premium amount and it is the wisdom of the share holders whether they want to subscribe to such a heavy premium.

The Revenue authorities cannot question the charging of such huge premium without any bar from any legislated law of the land.

The subscribers to the share capital are all companies. Who have filed confirmations of the transactions when the AO issued notice u/s. 133(6).

Identity of shareholders has been established beyond all reasonable doubts in fact the revenue authorities have not questioned the identity of the share holders.

The genuineness of the transaction can also be safely concluded since the entire transaction has been done through the banking channels duly recorded in the books of accounts of the assessee duly reflected in the financial statement of the assessee .

Not even a single evidence could be found which could lead to the transaction as sham.

The share holding pattern also cannot be said to generate any transaction which could be said to be sham.

The share holders in all the related transaction under issue are directly or indirectly related to the Government of India.

The Revenue authorities have erred in treating the share premium as income of the assessee u/s. 56(1).

The application of funds would be in the subsidiary companies.

The addition was deleted and matter stood decided in favour of assessee.

Authors observations:

It seems that in the above case revenue, as usual, indulged into un-necessary litigation by making addition u/s 56(1) in hands of company on account of share premium by treating premium as income, ignoring the fundamental difference between capital and income.