Introduction
The recent judgment by the Income Tax Appellate Tribunal (‘ITAT’) in ITO v. Solitaire BTN Solar (P) Ltd.[i] addresses a pivotal issue in corporate taxation: the valuation of shares issued by a subsidiary to its holding company and the applicability of s. 56(2)(viib) of the Income-tax Act, 1961 (‘Act’). This provision aims to tax excessive premiums received over the fair market value (‘FMV’) of shares. The ruling examines share valuation methods, the interpretation of deeming provisions, and the interplay between statutory mandates and intra-company transactions. This case, which revolved around the excess premium on optionally convertible preference shares (‘OCPS’), resulted in the dismissal of Revenue’s appeal and set a precedent for corporate entities engaged in similar financial structuring, shedding light on the boundaries of tax liability under s. 56(2)(viib) of the Act.
Brief Facts
The assessee, engaged in energy and infrastructure development business, had received approval to set up a 50MW solar plant in Tamil Nadu. The assessee filed its return of income (ROI) declaring total income at ‘Nil’ for assessment year (‘AY’) 2016-17, which was subjected to scrutiny assessment under s. 143(3) of the Act.
During the assessment, the assessing officer (‘AO’) observed that the assessee had issued and allotted 1,00,000 OCPS at Rs. 1,000/- each to its holding company, M/s Hindustan Clean Energy Ltd. (‘HCEL’), raising a premium of Rs. 9,90,00,000/-.
The AO deemed the premium of Rs. 990 per share as excessive and non-justifiable, rejecting the FMV declared by the assessee and recomputing the FMV of OCPS at Rs. 639.17 per share as against Rs. 1000/- per OCPS received by the assessee. This led to the addition of Rs. 3,60,83,000/- as taxable under s. 56(2)(viib) of the Act.
The assessee challenged this before the CIT(A), arguing the premium’s validity based on a Chartered Accountant’s (‘CA’) valuation and the intrinsic value of the shares. The CIT(A) ruled in favour of the assessee and deleted the addition made by the AO, leading to the Revenue’s appeal before the ITAT.
Held
The ITAT upheld the CIT(A)'s decision and dismissed the Revenue's appeal, finding the addition by the AO under s. 56(2)(viib) of the Act unjustified. The ITAT focused on the applicability of s. 56(2)(viib) and the valuation methods in reaching its conclusion. It was noted that the OCPS were allotted to HCEL, which held 100% of the assessee’s equity shares (‘ES’).
The ITAT emphasised that since HCEL was a 100% holding company of the assessee, no real income accrued to an outsider and hence, no unlawful gain could be envisaged in such intra-company transactions. Citing decisions such as BLP Vayu[ii] and Kissandhan Agri Financial Services[iii], the ITAT emphasised the deeming provision of s. 56(2)(viib) is inapplicable to intra-company transactions involving 100% holding companies and asserted that the section should be strictly construed.
Further, the ITAT upheld the assessee’s choice of the Discounted Cash Flow (‘DCF’) method for valuation, as permitted under r. 11UA(1)(c)(c) of the Income-tax Rules, 1962 (‘Rules’). The ITAT agreed with the assessee’s contention that the net asset value (‘NAV’) method applied by the AO, as prescribed by r. 11UA(2) of the Rules was applicable only in the case of ES, not OCPS, making the AO’s reliance on the NAV method inappropriate for preference shares.
Regarding the FMV calculation, the ITAT concurred with the CIT(A) that the AO erred in equating OCPS with ES without applying the proper conversion ratio. Correcting this, the FMV was recalculated at Rs. 993.48 per OCPS, justifying the premium of Rs. 1,000/- per share.
Our Analysis
This decision is significant for several reasons. Firstly, it emphasises the importance of the relationship between the holding company and the subsidiary company in the context of s. 56(2)(viib) of the Act. The ITAT noted that the deeming provisions of this section would not ordinarily be applicable when the shares are allotted to the same set of shareholders, effectively shielding transactions between holding companies and their wholly-owned subsidiaries.
Secondly, the decision underscores the necessity of selecting proper valuation methodologies corresponding to the nature of the financial instruments. The ITAT’s recognition of the DCF method for valuing preference shares aligns with global practices. It reinforces the principle that valuations done by the accountant in accordance with the applicable rule cannot be displaced without cogent reasons.
Thirdly, the precedents cited by the ITAT are noteworthy, establishing that s. 56(2)(viib) creates a legal fiction to tax a capital receipt as a taxable revenue receipt. However, applying these deeming provisions to the premium received from a holding company extends the scope of the provision excessively, taxing shareholders’ own money without any corresponding benefit. It was further laid down that in a case where the FMV is supported by an independent valuer’s report. The allotment is made to existing shareholders holding 100% equity, no change in interest or control over the money occurs by such issuance of shares, thus, making the chargeability of deemed income from such intra-company transactions contrary to the object of s. 56(2)(viib) of the Act.
However, there is also a flipside to this perspective. Such focus on the relationship between entities rather than the economic reality of the transaction undermines the purpose and essence of deeming provisions meant to address situations where the substance of a transaction, rather than its form, should be taxed. Additionally, by completely excluding such transactions from the ambit of s. 56(2)(viib), the ITAT may have opened the door for potential abuse. Companies might exploit this exemption to structure their capital to minimise tax liability, such as creating multiple layers of subsidiaries and issuing shares at inflated premiums within the corporate group, thereby eroding the tax base. While legally sound, this judicial perspective may inadvertently facilitate strategic financial structuring aimed at minimising tax liabilities through intra-group transactions.
End Notes
[i] [2024] 164 taxmann.com 170 (Delhi – Trib.), dated: 12.06.2024,
[ii] BLP Vayu (Project-1) (P) Ltd. v. PCIT, [2023]151 taxmann.com 47 (Delhi – Trib.), dated: 31.05.2023,
[iii] DCIT v. Kissandhan Agri Financial Services (P) Ltd., [2023] 150 taxmann.com 390 (Delhi – Trib.), dated: 15.03.2023,
Authored by Srishty Jaura, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.
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