Tax Implications On Shares Issued At Discount

ISSUE OF SHARES AT DISCOUNT - SECTION 53 OF THE COMPANIES ACT, 2013

PROHIBITION ON THE ISSUE OF SHARES AT DISCOUNT

1) Except as provided in Section 54, a company shall not issue shares at a discount.

(2) Any share issued by a company at a discount shall be void.

(2A) Notwithstanding anything contained in sub-sections (1) and (2), a company may issue shares at a discount to its creditors when its debt is converted into shares in pursuance of any statutory resolution plan or debt restructuring scheme in accordance with any guidelines, directions, or regulations specified by the Reserve Bank of India under the Reserve Bank of India Act, 1934, or the Banking (Regulation) Act, 1949.

(3) Where any company fails to comply with the provisions of this section, such company and every officer who is in default shall be liable to a penalty which may extend to an amount equal to the amount raised through the issue of shares at a discount or five lakh rupees, whichever is less, and the company shall also be liable to refund all monies received with interest at the rate of twelve percent per annum from the date of issue of such shares to the persons to whom such shares have been issued.

SECTION 54: ISSUE OF SWEAT EQUITY SHARES

(1) Notwithstanding anything contained in Section 53, a company may issue sweat equity shares of a class of shares already issued if the following conditions are fulfilled, namely:

(a) The issue is authorized by a special resolution passed by the company;

(b) The resolution specifies the number of shares, the current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued;

(c) -----

(d) where the equity shares of the company are listed on a recognized stock exchange, the sweat equity shares are issued in accordance with the regulations made by the Securities and Exchange Board on this behalf, and if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed.

(2) The rights, limitations, restrictions, and provisions as are for the time being applicable to equity shares shall be applicable to the sweat equity shares issued under this section, and the holders of such shares shall rank pari passu with other equity shareholders.

TAX IMPLICATIONS

Let's consider two scenarios:

1. Fresh issuance or
2. Allotment of shares,

Be it equity shares or preference shares, Section 56(2)(x) would apply in the hands of the person to whom such shares are issued or allocated if the shares are issued for consideration less than the fair market value.

Section 56(2)(x) of the Income Tax Act, 1961

In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes shall be chargeable to income tax under the heading "Income from other sources,"  namely:

(x) where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,

(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;

(b) any immovable property,

(A) without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property;

(B) for a consideration, the stamp duty value of such property as exceeds such consideration if the amount of such excess is more than the higher of the following amounts, namely:

(i) the amount of fifty thousand rupees; and

(ii) the amount equal to ten percent of the consideration:

Please note that if the fair market value of the property transferred is not more than 110% of the stamp duty value, then in this case, no addition shall be made as income in the hands of the transferee. Suppose an immovable property is transferred to Mr. A for Rs. 11,00,000/-. At the time of transfer, the SDV of the property was Rs. 10,00,000/-. In this case, nothing will be added to the income of Mr. A.

Provided that where the date of agreement fixing the amount of consideration for the transfer of immovable property and the date of registration are not the same, the stamp duty value on the date of agreement may be taken for the purposes of this sub-clause:

Provided further that the provisions of the first proviso shall apply only in a case where the amount of consideration referred to therein, or a part thereof, has been paid by way of an account payee check or an account payee bank draft or by use of an electronic clearing system through a bank account or through such other electronic mode as may be prescribed28, on or before the date of agreement for the transfer of such immovable property:

Provided also that where the stamp duty value of immovable property is disputed by the assessee on grounds mentioned in sub-section (2) of section 50C, the Assessing Officer may refer the valuation of such property to a Valuation Officer, and the provisions of section 50C and sub-section (15) of section 155 shall, as far as may be, apply in relation to the stamp duty value of such property for the purpose of this sub-clause as they apply for valuation of capital assets under those sections:

Provided also that in the case of property being referred to in the second proviso to sub-section (1) of section 43CA, the provisions of sub-item (ii) of item (B) shall have effect as if for the words "ten percent,"  the words "twenty percent" had been substituted;

(c) any property, other than immovable property,

(A) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;

(B) for a consideration that is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration:

Provided that this clause shall not apply to any sum of money or any property received:

(I) from any relative; or

(II) on the occasion of the marriage of the individual; or

(III) under a will or by way of inheritance; or

(IV) in contemplation of the death of the payer or donor, as the case may be; or

(V) from any local authority as defined in the Explanation to Clause (20) of Section 10; or

(VI) from any fund, foundation, university, or other educational institution, hospital, or other medical institution, or any trust or institution referred to in clause (23C) of Section 10; or

(VII) from or by any trust or institution registered under section 12A, section 12AA, or section 12AB; or

(VIII) by any fund, trust, or institution, or any university or other educational institution, or any hospital or other medical institution referred to in sub-clause (iv), sub-clause (v), sub-clause (vi), or sub-clause (via) of clause (23C) of section 10; or

(IX) by way of transaction not regarded as transfer under clause (i) or clause (iv) or clause (v) or clause (vi) or clause (via) or clause (viaa) or clause (vib) or clause (vic) or clause (vica) or clause (vicb) or clause (vid) or clause (vii) 30 [or clause (viiac) or clause (viiad) or clause (viiae) or clause (viiaf)] of section 47; or

(X) from an individual by a trust created or established solely for the benefit of a relative of the individual;

(XI) from such class of persons and subject to such conditions as may be prescribed;

(XII) by an individual, from any person, in respect of any expenditure actually incurred by him on his medical treatment or treatment of any member of his family for any illness related to COVID-19, subject to such conditions as the Central Government may, by notification in the Official Gazette, specify in this behalf;

(XIII) by a member of the family of a deceased person,

(A) from the employer of the deceased person; or

(B) from any other person or persons to the extent that such sum or aggregate of such sums does not exceed ten lakh rupees,

where the cause of death of such person is illness related to COVID-19 and the payment is:

(i) received within twelve months from the date of death of such person; and

(ii) subject to such other conditions as the Central Government may, by notification in the Official Gazette, specify in this behalf.

Explanation: For the purposes of clauses (XII) and (XIII) of this proviso, "family" in relation to an individual shall have the same meaning as assigned to it in Explanation 1 to clause (5) of Section 10:

Provided further that clauses (VI) and (VII) of the first proviso shall not apply where any sum of money or any property has been received by any person referred to in sub-section (3) of section 13.

Explanation: For the purposes of this clause,

(a) The expressions "assessable,"  "fair market value,"  "jewellery,"  "relative," and "stamp duty value" shall have the same meanings as respectively assigned to them in the explanation to clause (vii); and

(b) The expression "property" shall have the same meaning as assigned to it in clause (d) of the explanation to clause (vii) and shall include virtual digital assets.

As stated above, the wordings of 56(2)(x) of the IT Act are very broad, and they create a deeming fiction whereby if any person receives any property from any other person for a consideration less than the fair market value of the property, they shall be deemed to have taxable income from the transaction.

The deeming fiction created is a departure from the common understanding of the meaning of the word 'income'. Hence, for any reason, if the transaction does not fall within the strict wording of the deeming fiction, the fiction would not be attracted.

Rule 11U, read with Rule 11UA of the IT Rules, provides for the determination of fair market value for various situations and purposes.

• In our view, Section 56(2)(x) would not be attracted in the hands of the person to whom such shares are issued or allotted if the shares are issued for consideration less than the FMV due to the following reasons:.
• Firstly, Section 56(2)(x) of the IT Act brings to tax the receipt of property by any person 'from any other person'. Therefore, to fall within the ambit of taxation under this section, the property should be'received from any person'. A property can be received from any person, but only if the other person from whom it is received holds the property before conveying it further. It is a well-settled principle that, in the case of the issue of shares, the shares come into existence for the first time only when they are allotted to the shareholders. An issue of shares is the creation of the property for the first time. When the shares are allotted to the shareholders, such allotment would not amount to the receipt of property 'from another person'.
• Secondly, the section is an anti-abuse provision, inserted after the abolition of the Gift Tax Act, which was introduced to prevent the laundering of unaccounted monies. The anti-abuse provision, therefore, will not apply to the genuine issue of shares to shareholders. Thus, if, due to a justifiable commercial reason, the issue of shares is done at a price less than the fair market value of those shares, there is no abuse of the provisions of the law, and hence Section 56(2)(x) would clearly not apply.
• Thirdly, no tax can be levied on the shareholders for exercising their option under the contract. When laws are made by representatives of the people, it can be presumed that the lawmaker had in mind what society considers honest, fair, and reasonable. The Legislature could not have intended to tax a person for performing his obligations under a contract. By no degree of fairness and justice, where there is clearly no understatement of consideration in respect of the transfer and the transaction is perfectly honest and bona fide and, in fulfillment of a contractual obligation, the shareholders should be liable to pay tax on gains that have not accrued or arisen to them.

CONCLUSION

The issue discussed hereinabove, though having significant commercial implications, has not been subject to much judicial interpretation. While the Karnataka High Court has held that a fresh issue of shares would not be regarded as 'a receipt' of property as contemplated in the Section, the Income-tax Tribunal has taken a contrary view. The order of the Tribunal is under challenge before the Bombay High Court. In any case, for the detailed reasons discussed in the earlier paragraphs, a fresh issue of shares by a company, either under a right issue or preferential allotment, should not be subject to tax in the hands of the shareholder under Section 56(2)(x) of the Income Tax Act.

Disclaimer: The article presented here is only for sharing information with readers. In cases of necessity, consult with professionals.