The Hon’ble Himachal Pradesh High Court (“HC”) has recently issued a significant ruling in the case of M/s Pr. Commissioner of Income Tax-1, Chandigarh Versus M/s. I.A. Hydro Energy (P) Limited1 concerning the taxability of premium arising from the conversion of loans to equity under section 56(2)(viib) of the Income-tax Act, 1961 (‘the Act’). In the instant case, the High Court held that section 56(2)(viib) of the Act shall not apply in cases where no consideration is received on conversion of loan into equity shares.
Judgement referred: Creditalpha Alternative Investment Advisors (Pvt.) Ltd.2
Facts
- Assessee is engaged in the business of generation and distribution of Hydro Electricity in the state of Himachal Pradesh.
- The Assessee was having an opening balance of unsecured loans as on 01.04.2017, which were converted into share capital as per the agreement during the said year. The share subscribers were partners in the erstwhile Assessee-firm and the balances were showing as Partners capital account.
- Assessing Officer (‘AO’) made an addition of INR 202.50 Crores income under Section 56(2)(viib) of the Act on account of excess amount per share paid as premium and rejected the Valuation report furnished by the Assessee holding that the Discounted Cash Flow (‘DCF’) valuation used by the Assessee is bogus and has no connection with the real figures.
- Aggrieved by the order, the Assessee filed an appeal before CIT (Appeals). The Appellate Authority deleted the additions made by the AO and held that since no money/consideration was received by the Assessee on issue of shares, section 56(2)(viib) is not applicable. It also held that the valuation done by the Assessee as per DCF method is a permissible methodology under Rule 11UA(2)(d) of the Income Tax Rules, hence cannot be rejected without valid reasons.
- The AO challenged this order before the ITAT3 and the Tribunal upheld the views of CIT (Appeals) on non-applicability of section 56(2)(viib) and permissible methodology of valuation.
- Against the rejection order passed by the ITAT, present petition has been filed before the HC.
- AO contended that the conversion of pre-existing unsecured loans of partners/shareholders into equity shares at premium is taxable under the head “Income from Other Sources” under Section 56(2)(viib) on account of excess amount per share paid as premium.
- The AO further claimed that the Assessee’s use of the DCF valuation method was based on fictitious figures having no correlation with actual affairs of the Assessee’s business. Accordingly, the AO recomputed the fair market value of the unquoted shares on the basis of balance sheet figures as per NAV method and issued his order.
- Assessee contented that no consideration was received for the issuance of shares in exchange for the conversion of unsecured loans hence the provisions of section 56(2)(viib) should not be applicable.
- Additionally, the Assessee asserted that a certificate from a Chartered Accountant was procured to value the shares as per the DCF method prescribed under Rule 11UA of the Income-tax Rules, 1962 (IT Rules).
- Whether AO has the authority to substitute DCF method of share valuation, as opted by the Assessee, with NAV method?
- Whether provisions of section 56(2)(viib) of the Act applies in case of conversion of loan to equity shares?
- The HC upheld the ITAT’s contention that the consideration in the form of unsecured loans were received from the Partners of the erstwhile Assessee-firm in the year 2010, as evidenced from loan agreement, and the AO could not bring out any material facts to show that such conversion of loans to equity shares was a ploy to defraud revenue of the tax on such transaction.
- Therefore, conversion of loan to equity does not fall under the definition of “any consideration for issue of shares received in the previous year” or result in any tax abuse as contended by the AO as no substantial evidence was presented in the instant case.
- In light of the above, HC affirmed that section 56(2)(viib) of the Act is not applicable since no money/consideration was received by the Assessee upon the issuance of shares. The shares were allotted merely on account of conversion of outstanding loans received in earlier years and the source of these loans was satisfactorily explained.
- Whether AO has the authority to substitute DCF method of share valuation, as opted by the Assessee, with NAV method?
The HC, in concurrence to the ITAT and CIT(Appeals) order, ruled that the AO lacks the authority to selectively pick and choose a valuation method for shares, as the discretion in this regard is explicitly granted to the Assessee. The HC reiterated that the AO’s role is limited to scrutinizing the valuation method chosen by the Assessee and that the AO has no jurisdiction to replace it with a different method, once a particular prescribed method has been adopted by the Assessee.
- In this significant ruling, the HC brings much-needed clarity on the issues involved pertaining to the non-applicability of section 56(2)(viib) of the Act on account of the conversion of existing unsecured loans into equity shares at a premium when no consideration is received wherein different courts had divergent views like Mumbai Tribunal4 had held that angel tax will not be applicable in the absence of receipt of consideration on conversion whereas on the contrary the Kolkata Tribunal5 had held that conversion will attract angel tax as consideration cannot be restricted to monetary consideration.
- HC, further, reiterated that while the AO retains the right to challenge the Assessee’s valuation report however they are bound by the method chosen by the Assessee and cannot alter it.
[1] TS-395-HC-2024(HP) / ITA No.4 of 2024
[2] (2022) 134 Taxmann.com 223 (Mumbai)
[3] Income Tax Appellate Tribunal – Bench ‘A’, Chandigarh – ITA no. 548/CHD/2022
[4] Rankin Infrastructure Pvt Ltd. ((2022) 142 taxmann.com 37 (Mumbai Trib.))
[5] Milk Mantra Dairy (P.) Ltd. ((2022) 140 taxmann.com 163) (Kolkata – Trib))
