Introduction
In the case of Aditya Vijay Mirchandani v. Income-tax Officer[i], the Hon’ble High Court of Bombay (‘BHC’) addressed the issue of taxing notional appreciation in share value. The BHC specifically examined whether such notional appreciation constituted a taxable event in the relevant assessment year (‘AY’) 2016-17 under the Income-tax Act, 1961 (‘Act’). The dispute arose when the assessing officer (‘AO’) issued a notice under s. 148A(d) of the Act, alleging that income had escaped assessment due to a significant disparity between the allotment price of equity shares and their market value. This case required the BHC to interpret the provisions of the Act, particularly regarding the concept of notional profit and its implications for capital gains taxation.
Brief Facts
Preferential Allotment: In February 2014, the Assessee was allotted 2,00,000 equity shares of Kamalakshi Finance Corporation Ltd. (‘KFCL’) at a preferential price of Rs. 13 per share. Since these shares were not immediately available for open market trading, their initial valuation remained at Rs. 13 per share.
Market Appreciation: By January 2015, the market value of these shares had appreciated to Rs. 659 per share, reflecting a notional gain of Rs. 12.88 crores. This substantial appreciation was primarily driven by market activities and investor behaviour, which later came under suspicion of being influenced by manipulative practices.
Regulatory Scrutiny: The sharp rise in KFCL’s share price caught the attention of regulators, including the tax department, leading to increased scrutiny. The Security and Exchange Board of India (‘SEBI’) investigated the trading activity of KFCL shares, suspecting that the price increase was artificially inflated. This investigation suggested that these practices aimed to allow those allocated shares (allottees) to make significant profits by selling them at inflated prices.
Notice of Reassessment: Based on a report from the Indian Audit and Account Department, which included information from an ex parte ad interim order by SEBI, the AO issued a notice under s. 148A(d) of the Act, alleging that a notional profit of Rs. 12.88 crores had escaped assessment. This discrepancy arose due to the substantial difference between the allotment price of Rs. 13 and the market price of Rs. 659. The AO contended that this notional gain should be taxed as it represented an increase in the Assessee’s wealth during the relevant AY.
The contention of the Parties: The Assessee responded to the notice by asserting that no sale of shares took place during AY 2016-17. They emphasized that no capital gain or taxable event could be triggered without an actual sale. To support their claim, the Assessee provided evidence, including their Demat account statement, demonstrating that the shares remained unsold throughout the relevant AY, thereby refuting the notion that any income had escaped assessment. On the other hand, Revenue acknowledged that the shares had not been sold in AY 2016-17 and that the purported notional profit was based solely on market price appreciation.
Held
The BHC ruled in favour of the Assessee, determining that the increase in the value of the shares (notional appreciation) did not constitute taxable income as capital gains. The BHC emphasized that for income to be taxed as capital gains, there must be an actual sale of the assets. In this case, since no sale of shares took place during AY 2016-17, there was no taxable event, and therefore, no income escaped assessment.
The BHC reiterated that the mere increase in an asset’s market value, without a corresponding sale, did not constitute a taxable event. Therefore, the basis for reassessment was invalid as it lacked a concrete taxable event.
The BHC criticized the AO for failing to consider the explicit facts presented by the Assessee properly. It emphasized that the reassessment notices and the subsequent proceedings lacked application of mind. The Assessee had clearly demonstrated, through documentary evidence such as the demat account statement, that no sale of shares had taken place during the relevant AY. Consequently, the BHC quashed the impugned order passed under s. 148A (d) of the Act, emphasizing that the reassessment was baseless and did not withstand legal scrutiny.
Our Analysis
The recent BHC decision reaffirms a fundamental requirement under the Act that taxable income, especially capital gains, necessitates a tangible event such as a sale or transfer of assets. The judgment emphasizes judicial scrutiny of reassessment proceedings based on hypothetical gains (notional gains). While excluding paper profits from the ambit of taxable events, this decision reflects judicial scrutiny over the Revenue’s reliance on reports and orders from other bodies without independent application of mind. This safeguards taxpayer rights and ensures that tax assessments adhere to substantive legal principles. In simpler terms, the ruling strengthens protections against unjustified reassessments based on unrealized gains. It also underscores the judiciary’s role in ensuring tax assessments are based on concrete, realizable events. This decision serves as a pivotal precedent in the domain of capital gains taxation, clearly delineating the distinction between hypothetical and realized gains under the Act.
End Note
[i] [2024] 164 taxmann.com 161 (Bombay), [24-06-2024].
Authored by Siddharth Jha, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.
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