2022 (8) TMI 220 - AT - Income Tax

Addition u/s 56(2)(viia) - difference between the Fair Market Value (FMV) of the shares and the consideration paid when they are bought back - company buys back its own shares from the shareholders whereby the liability is reduced - HELD THAT - As shares should become property of the recipient company in order to apply the provisions under section 56(2)(viia) of the Act and in that case, such shares should be the shares of other company and cannot be its own shares, because a company cannot hold its own shares in order that such shares become its property. Provisions under section 56(2)(viia) should be applicable only in cases where the receipt of shares become property in the hands of the recipient and the shares shall become property of the recipient only if those are shares of any other company . With reference to the buying back of own shares by a company which become extinguished by reducing the capital, it is clear that the test of becoming property and also shares of any other company fails thereby rendering the provisions under section 56(2)(viia) of the Act inapplicable to the cases of buyback of own shares. No other view of any higher fora is brought to our notice. We, therefore, while respectfully following the view taken in the case of Vora Financial Services (P) Ltd., 2018 (7) TMI 64 - ITAT MUMBAI hold that the addition made by invoking the provisions u/s 56(2)(viia) of the Act cannot be sustained. We accordingly allow the appeal of the assessee.

Summary

Issues Involved:
1. Applicability of section 56(2)(viia) of the Income Tax Act to the buy-back of shares.
2. Interpretation of the term "property" under section 56(2)(viia) in the context of buy-back transactions.
3. Legislative intent behind section 56(2)(viia) and its applicability.

Detailed Analysis:

1. Applicability of Section 56(2)(viia) of the Income Tax Act to the Buy-Back of Shares:

The primary issue revolves around whether section 56(2)(viia) of the Income Tax Act applies to the buy-back of shares by a company from its shareholders. The assessee argued that the provisions of section 56(2)(viia) do not apply to buy-back transactions because the company does not 'receive' the shares in a manner that would make them taxable under this section. Specifically, the assessee contended that:
- The company does not hold the shares post buy-back, thus it does not 'receive' them.
- Section 56(2)(viia) requires the involvement of three elements: a transferor, a closely held receipt company, and shares of another closely held company. In buy-back transactions, the company buys back its own shares, not the shares of another closely held company.
- The shares bought back do not have any value post buy-back and are extinguished, so they cannot be considered property received with money's worth under section 56(2)(viia).

The Assessing Officer (AO) disagreed, asserting that:
- There is no exemption for buy-back transactions under section 56(2)(viia).
- The section applies if a closely held company receives shares of another closely held company for consideration less than the Fair Market Value (FMV), and the difference should be taxed as 'income from other sources'.
- The destruction or extinction of shares post buy-back is immaterial to the applicability of section 56(2)(viia).

The AO thus made an addition to the taxable income based on the difference between the FMV and the consideration paid for the shares.

2. Interpretation of the Term "Property" under Section 56(2)(viia) in the Context of Buy-Back Transactions:

The assessee argued that the shares bought back by a company do not constitute 'property' in the hands of the company under section 56(2)(viia). The term 'property' in this context should refer to shares of another company, not the company's own shares. The Coordinate Bench of the Mumbai Tribunal in the case of Vora Financial Services (P) Ltd. supported this view, stating that:
- The provisions of section 56(2)(viia) are applicable only when the shares received become property in the hands of the recipient company, which means they should be shares of another company.
- A company cannot hold its own shares as property, and thus, buy-back transactions do not fall under the purview of section 56(2)(viia).

The Tribunal in the present case agreed with this interpretation, concluding that the provisions of section 56(2)(viia) do not apply to buy-back transactions because the shares do not become property of the company post buy-back.

3. Legislative Intent Behind Section 56(2)(viia) and Its Applicability:

The Tribunal examined the legislative intent behind section 56(2)(viia) as explained in the Memorandum to the Finance Bill, 2010. The intention was to prevent the practice of transferring unlisted shares at prices below their FMV to firms or companies, which could be a means of laundering unaccounted income. However, this anti-abuse provision was not intended to apply to transactions in the normal course of business, such as buy-back of shares.

The Tribunal held that:
- The primary condition for invoking section 56(2)(viia) is that the shares should become a 'capital asset' and property in the hands of the recipient.
- In buy-back transactions, the shares are extinguished and do not become property of the company, thus failing the test of 'becoming property' and 'shares of another company'.

Conclusion:

The Tribunal allowed the appeals of the assessee, holding that section 56(2)(viia) does not apply to buy-back transactions. The addition made by the AO under this section was not sustainable. The decision was based on the interpretation that the shares bought back do not become property of the company and the legislative intent behind the provision. The findings in this case were applied mutatis mutandis to the subsequent assessment year, resulting in the allowance of both appeals.

Order Pronounced:
Both appeals of the assessee were allowed, and the order was pronounced in the open court on August 3, 2022.