The Chandigarh Bench of the Income Tax Appeal Tribunal (ITAT) in its recent decision in Electra Paper and Board Pvt Ltd v. IoT [ITA NO.222/Chd./2021] held that for the calculation of the fair market value (FMV) of shares in a company, for the purposes of section 56(2)(viib) of the Income Tax (Computers Act) Act 1961 , the unaudited balance sheet established as at the valuation date should be sufficient, if this unaudited balance sheet is subsequently audited without there being any difference between the audited and unaudited figures.
Pursuant to Section 56(2)(viib) of the Information Technology Act, if a private company issues shares to residents at a price greater than the FMV of its shares, then such share premium excess is taxable in the hands of the company (generally referred to as “welfare tax”). For the purpose of determining this FMV, the Valuation Rules (Rule 11U and Rule 11UA of the Income Tax Rules 1962 (IT Rules)) define the term “balance sheet” as – the balance sheet of the company as that it is based on the valuation date (i.e. the date of issue of the shares) which has been audited by the company’s auditor appointed under the Companies Act, and if no balance sheet is drawn up on the valuation date, then the balance sheet drawn up on a date immediately preceding the valuation date which has been approved and adopted by the annual general meeting of the company.
- The assessed, a limited company (taxpayer) issued shares on 31 March 2016 (date of issue) at INR 20, in accordance with the FMV of such shares derived from the unaudited balance sheet of the taxpayer as of the date of episode.
- Subsequently, during the assessment procedure for the 2016-2017 fiscal year, the tax officer found that the balance sheet at the date of issue was not audited, the last audited balance sheet of the taxpayer as of March 31 2015 should have been used for purposes of determining the FMV of the taxpayer’s shares for purposes of the angel tax provisions. Based on this, the FMV of the taxpayer’s shares was determined at INR 17.32. Since the issue price was above said FMV, the premium at FMV i.e. INR 2.68 per share (the difference between 20 and 17.32) totaling INR 8,55,590, was been taxed as the taxpayer’s income under the IT welfare tax provisions. Act.
- On appeal to the first instance of appeal, the supplement made by the tax officer was confirmed. Thus, the Taxpayer appealed to the Chandigarh bench of the ITAT.
The ITAT has referred to the definition of “balance sheet” under Rule 11UA of the IT Rules to determine which balance sheet should be referred to in determining the FMV of shares for the purposes of the provisions relating to providential tax. Accordingly, ITA noted that the relevant balance sheet would be either: (a) the balance sheet as prepared at the valuation date and which has been audited by an auditor; or (b) if a balance sheet is not drawn up on the valuation date, then such balance sheet drawn up on a date immediately preceding the valuation date and audited by the auditors.
The ITA observed that in this case, since a balance sheet was already drawn up at the date of issue, the Taxpayer’s case fell within part (a) of the definition of “balance sheet”. With respect to the requirement for this balance sheet to be audited, ITAT considered that there is no requirement under part (a) of the definition for this balance sheet to be drawn up on the date of issue also be audited on the same date and considered that it would be sufficient for it to be subject to a subsequent audit.
The ITA noted that, in the case of the Taxpayer, the balance sheet as at the Issue Date was subsequently audited and that there was no difference between the unaudited and audited position. Thus, the FMV derived by the taxpayer on the basis of its unaudited balance sheet, as established on the date of issue, has been deemed by the ITAT to comply with the providential tax provisions.
Accordingly, the Taxpayer’s appeal was allowed and the addition made by the tax authorities was set aside.
The finalization of a company’s accounts followed by an audit is a lengthy process – it involves considerable effort, including the exercise of professional judgment on the part of the company’s management as well as its auditors. It is therefore practically impossible for companies to finalize their accounts and have them audited immediately on the same date. The ITA recognized these practical considerations and provided relief to the taxpayer.
In particular, similar valuation requirements apply to the transfer of shares under Article 50CA and 56(2)(x) of the Computer Law for the transferor as well as for the recipient of the shares. In accordance with these provisions, if the shares are transferred at a value lower than their FMV, then there could be tax consequences for the transferor as well as for the beneficiary on a determinative basis. For the purposes of determining the FMV of the shares with regard to the aforementioned provisions, the valuation rules define the “balance sheet” as – the balance sheet of the company as drawn up on the valuation date and which has been audited by the auditor of the company appointed under applicable law relating to companies. Thus, this decision should also provide important guidance regarding those transactions and as long as there is no material difference between the audited and unaudited financial statements, the unaudited financial statements as of the valuation date (being the date of transfer of shares in accordance with applicable rules), audited later, should be considered sufficient compliance.
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