Section 56(2)(viib) is not triggered on the excess consideration/asset received by the amalgamated company in lieu of issue of shares issued

Facts of the case:

In the scheme of amalgamation approved by the Gujarat High Court, the assets and liabilities of the amalgamating company was transferred to the Assessee being the amalgamated company.  In lieu of such transfer, the Assesse company issued its shares to the shareholder of amalgamating company.  The difference between value of shares issued and net assets were recorded by the Assessee Company as capital reserve in its books of accounts. 

The Assessing Officer at the time of processing the return, taxed the difference between Net Assets and Value of Shares as income under Section 56(2)(viib) of the Income Tax Act, 1961 (Act) in the hands of the Assessee.  It held that the consideration received as value of assets exceeds the fair market value of shares, thus is taxable under the afore said provision.

Against this, the Assessee preferred an appeal to the fist appellate and the first appellate held its decision in favour of the Assessee on the basis that deeming provisions of Section 56(2)(viib) of the Act do not cover such transactions.  The amalgamated company being the Assessee did not receive any consideration in lieu of shares issued, hence Section 56 of the Act provisions shall not apply. 

The order of the first appellate was challenged by the Revenue in an appeal before the Income Tax Appellate Tribunal (Tribunal) on the grounds that the provisions of Section 56(2)(viib) of the Act are applicable in case where the value of net assets receive are more than the value of shares issued even though such shares are issued pursuant to the scheme of amalgamation.  Before the Tribunal, Revenue contented that the Assessee received benefit by way of excess consideration in kind over the value of its shares issued to the shareholders of amalgamating company.  Therefore, such benefit i.e. difference between value of shares and net asset value should be taxable in the hands of the Assessee as income from other sources.

The Revenue’s argument was countered by the Assessee and the Assessee stated that such difference between the net assets and value of shares is a notional amount which is recorded in the books of accounts, therefore the deeming provisions of Section 56(2)(viib) cannot apply. Such notional amount which is recorded in the capital reserve account cannot be treated as share premium or consideration, thus taxable as such.  Further, no consideration is paid by the amalgamating company for issue of such shares, all that the Assessee get is the Assets less liabilities in lieu. 

Basis the above, the Tribunal held as below:  

As held:

Section 56(2)(viib) of the Act deals with situation where consideration is received and such consideration is in excess of the value of shares issued.  The scope of Section 56(2)(viib) of the Act was defined in the Memorandum of the Finance Bill where in the intention of the legislature was to tax those transactions where the share premium money was unjustifiably received by the companies, thus making such issue of shares as source of converting unaccounted money into share capital. 

It is a deeming provision inserted by the legislature where in capital receipts are held as income in the hands of the recipient of such sums of money.  Being the deeming fiction, it should be construed strictly as held by the Supreme Court in the case of CIT vs. Mother India Refrigeration (P) Ltd. (1985) 155 ITR 711. 

Also, the provisions of of Section 56(2)(viib) apply to bilateral agreements and in this case, it being a tripartie agreement between amalgamating company, the Assesse and shareholders of the amalgamating company, hence, the section shall not apply.  The issue of shares in the scheme of amalgamation is to give effect to the court orders and there is no consideration that is received for issuance of such shares.

Further, Section 47( vii) of the Act also provides exemption to the shareholders from capital gains on transfer of shares by the shareholders of the amalgamating company in consideration for issue of shares of the amalgamated company i.e. the Assessee in this case.  Thus, the intention of the legislature is to grant tax neutrality to such transfer under the scheme of amalgamation.

Observation:

The provisions of Section 56(2)(viib) are deeming tax provisions and have limited application.  Business re-organization by way of an amalgamation have been specifically excluded by the Tribunal in this case.  The strict interpretation to deeming provisions as done by the Tribunal will give tax payers some respite from over zealous approach often adopted by the Revenue authorities to otherwise genuine transactions.  Though, the test of General Anti Avoidance Rules (GAAR) is still to be seen had it been invoked in such situations.

Source: DCIT Circle 3(1)(2), Ahmedabad v. M/s. Ozone India Ltd. on 13.04.2021