2024 (2) TMI 1035 - AT - Income Tax

Addition u/s 56(2)(viib) r.w.r 11UA - excess premium charged - issuance of preference shares to the director/ex-director of the assessee company - Addition sustained by the CIT-A - whether or not the preference shares issued by the assessee company @ Rs.110/- per share was at Fair Market value (FMV)? - determining the FMV of the subject preference shares as per the dividend discounting method , i.e., at Rs.5/- per share as against that issued by the assessee at Rs.110/- per share Whether or not the A.O is right in rejecting the valuation of the preference shares that were issued by the assessee company to director and ex-director by adopting the Net Asset Value method, and substituting the same by dividend discounting method ? Anti-tax abuse provision - HELD THAT - Admittedly, it is a matter of fact borne from the record that the legislature in all its wisdom had inserted the provisions of Section 56(2)(viib) as a part of its counter-tax evasion mechanism to deter the generation and use of unaccounted money. Although the contention of the AR that now when the genuineness of the transactions of issuance of preference shares by the assessee company to its director/ex-director had been proved to the hilt, therefore, there was no justification for the A.O to have triggered the deeming provisions of Section 56(2)(viib) i.e a counter tax evasion provision, at first blush appeared to be convincing, but going by the rule of strict literal interpretation that has to be adopted while construing the scope and gamut of a statutory provision the same does not merit acceptance. As Section 56(2)(viib) does not carve out any exception as regards the applicability of the same in a case where the shares are issued to the directors of the company, therefore, the aforesaid contention of the Ld. AR that the same would not apply to the preference shares issued by the assessee company to its director/ex-director cannot be accepted. It is only in cases of ambiguity that the court can use other aids to discern the true meaning but where the statute is clear and the words plain, the legislation has to be given effect in its own terms. We are unable to concur with the Ld. AR, who had tried to circumscribe the applicability of Section 56(2)(viib) of the Act by reading in it an exception as regards the applicability of the same to a specific class of persons, which, in the absence of anything to the said effect having been made available on the statute by the legislature cannot be accepted on our part. The Ground of appeal No. 2 is dismissed. Observations of the A.O while determining FMV of preference shares as per dividend discounting model - Redemption of preference shares at the end of 20 years at the same value i.e. Rs.110/- - As stated by the Ld. AR, and rightly so, a perusal of the Special Resolution passed in the extraordinary general meeting of the assessee company reveals that the subject 7,78,000 nos. of non-cumulative redeemable preference shares were redeemable not later than 20 years from the date of allotment - We find that the A.O while referring to the allotment and conditions based on which, the preference shares were issued by the assessee company, had categorically acknowledged the fact that the subject preference shares were redeemable within 20 years of allotment at a premium of not less than Rs.100/- each; or shall be converted into similar nature of equity shares. In fact, the period of 20 years is the maximum statutory period for redemption and as per the terms of allotment of preference shares, the entire premium is redeemable. Accordingly, we concur with the claim of the Ld. AR that the observation of the A.O. that the subject preference shares under consideration were redeemable at the end of 20 years at the same value, i.e, Rs.110/- per share is factually incorrect and contrary to the facts discernible from the records. Convertibility of preference shares into equity shares not considered by the A.O - As per the Special Resolution passed in the Extraordinary General Meeting of the assessee company it was specifically provided that the said preference shares shall be redeemed on not less than Rs.110/- each; or it shall be converted into a similar number of fully paid up equity shares by obtaining permission from all preference shareholders. As in a case where the preference shares are convertible into equity shares, the fair market value of such shares would be more than the non-convertible preference shares or debt instruments, therefore, we find substance in the claim of the Ld. AR that the A.O. had grossly erred in losing sight of the material fact that the subject shares were optionally convertible non-cumulative redeemable preference shares, which, thus, had a strong bearing on the determination of the FMV vis- -vis. nonconvertible preference shares or debt instruments. Observation of the A.O that the assessee company will pay a 10% dividend - As the terms of issuance of the preference shares itself provide for a 100% dividend, i.e. the coupon rate is 100%, therefore, there could have been no justification for the A.O. in assuming payment of 10% dividend every alternate year by the assessee company. Because the terms of preference shares itself provide for a 100% dividend, thus, the aforesaid assumption of the AO that the assessee company would pay a 10% dividend being devoid and bereft of any basis cannot be accepted. Also, we are unable to comprehend on what basis the AO had assumed that the dividend would be paid by the assessee company every alternate year. Once again, as the aforesaid assumption of the A.O. is not backed by any concrete basis, therefore, the same cannot be subscribed on our part. Discounted rate of 12% taken by the A.O - A.O. had not referred to any comparable instance and had arrived at his aforesaid view based on a general observation. Apart from that, we concur with the Ld. AR that the assumption of the A.O. wherein he had compared the discount rate for secured debt and equity is not only without any basis but also unrealistic. Although, some of the terms of the preference shares match with the debt instruments, but the same on the said standalone basis could not be treated as a simpliciter debt instrument. Accordingly, we find substance in the contention of the Ld. AR that there is no justification for the A.O. in treating preference shares as a debt or a quasi-debt instrument, and thus, consider the discounting rate on that basis for estimating the FMV of the subject preference shares. Also, we find substance in the Ld. AR s contention that the bank FDR rate as was prevailing during the year in question should have been taken as the appropriate rate of return. Subscription of the preference shares by the promoters of the assessee company - A.O., without placing on record any material could not have merely on the ground that the subject preference shares were issued to related parties, drawn adverse inferences as regards the price at which they were subscribed by the aforementioned persons Because the factual observations and assumptions of the A.O., as observed by us hereinabove, suffer from certain serious lapses/infirmities that had crept in while determining the FMV of the subject preference shares based on the dividend discounting method by the A.O., therefore, we are of the view that the matter in all fairness requires to be revisited by the A.O who is directed to redetermine the FMV of the subject preference shares in the backdrop of our aforesaid observations as regards the respective issues. Needless to say, the A.O., in the course of set-aside proceedings shall afford a reasonable opportunity of being heard to the assessee company which will remain at liberty to substantiate its claim based on fresh documentary evidence, if any. A.O rejecting the Net Asset Value method adopted by the assessee company for determining FMV of the subject preference shares - As the subject shares are optionally convertible non-cumulative redeemable preference shares, which, as observed by the A.O in the body of the assessment order, as per the terms and conditions on which they have been issued by the assessee company, inter alia, in the event of winding up shall not be entitled to its assets, therefore, their FMV in our view cannot be safely determined based on the Net Asset Value (NAV) method. At the same time, we are of the view that the fact that the subject shares are optionally convertible preference shares would in itself be a primary factor to be considered in the backdrop of the unlisted equity shares, and thus, will have a strong bearing while determining of their FMV by an analyst. We, thus, in terms of our aforesaid deliberations direct the A.O to redetermine the FMV of the subject preference shares subject to our observations recorded as regards the mistakes/infirmities that had crept in the determination of the same. The Ground of Appeal No. 1 is partly allowed for statistical purposes in terms of our aforesaid observations.

Summary

Issues Involved:
1. Addition under Section 56(2)(viib) read with Rule 11UA on account of excess premium charged.
2. Invocation of Section 56(2)(viib) read with Rule 11UA.
3. Addition without issuing a show cause notice, against the principle of natural justice.

Summary:

Issue 1: Addition under Section 56(2)(viib) read with Rule 11UA on account of excess premium charged
The assessee company issued preference shares at a premium, which the Assessing Officer (A.O.) revalued using the "dividend discounting method" instead of the "Net Asset Value" (NAV) method used by the assessee. The A.O. determined the fair market value (FMV) of the preference shares at Rs. 5 per share, leading to an addition of Rs. 8,16,58,500/- under Section 56(2)(viib) read with Rule 11UA. The Tribunal found that the A.O.'s assumptions, such as the redemption value and dividend payment, were factually incorrect and directed the A.O. to revisit the FMV determination considering the Tribunal's observations.

Issue 2: Invocation of Section 56(2)(viib) read with Rule 11UA
The Tribunal upheld the applicability of Section 56(2)(viib), rejecting the assessee's argument that the provision should not apply to genuine transactions involving directors. The Tribunal emphasized that the statutory provision does not carve out exceptions for specific classes of persons and must be interpreted literally. Additionally, the Tribunal found that the A.O. was justified in rejecting the NAV method for preference shares, as they do not carry ownership stakes like equity shares. The Tribunal directed the A.O. to redetermine the FMV of the preference shares, considering the Tribunal's observations.

Issue 3: Addition without issuing a show cause notice, against the principle of natural justice
The Tribunal dismissed this ground as not pressed by the assessee's Authorized Representative.

Conclusion:
The appeal was partly allowed for statistical purposes, directing the A.O. to redetermine the FMV of the preference shares based on the Tribunal's observations. The Tribunal upheld the applicability of Section 56(2)(viib) and rejected the NAV method for valuing preference shares. The issue of addition without a show cause notice was dismissed as not pressed.