I took up a rights issue at face value. Is the gap from book value taxable in my hands?
Not on the proportionate part. Where further shares are offered to existing shareholders pro-rata to their holdings, there is only an apportionment of the value of the existing holding over more shares and nothing is received. Anything allotted beyond the proportionate entitlement is a different matter and can be taxed.
Decided by the ITAT (Income Tax Appellate Tribunal, Mumbai Bench 'A' - D. Manmohan (Vice-President) and Sanjay Arora (Accountant Member); AY 2010-11) on 2014-03-12, reported as [2014] 45 taxmann.com 176 (Mumbai - Trib.) / 148 ITD 260 (Mum.); 2014-TIOL-150-ITAT-MUM; IT Appeal No. 4887 (Mum.) of 2013 and SA No. 192 (Mum.) of 2013. It bears on section 56(2)(vii)(c), section 56(2)(x), section Rule 11UA of the Income Tax Act 1961, in Gifts, Shares & Angel Tax matters.
This is the working rule for every below-value rights issue in a closely held company: measure the allotment against the proportionate entitlement, and only the excess is in play. It cuts both ways — the Tribunal also held that a fresh allotment is within the section even though there is no transfer, so the argument that nothing was 'received' because the shares did not previously exist is closed off. Where shares declined by other shareholders are picked up, that portion is where the exposure sits.
Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere.
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The assessee held 3,01,316 shares, about 4.98 per cent, of Dorf Ketal Chemicals India Pvt. Ltd. The company offered further shares at the face value of Rs. 100 each on a proportionate basis, the assessee's entitlement being 3,13,624 shares, roughly twenty-one for every share held, against a book value of Rs. 1,538 per share as on 31 March 2009. The assessee took up only 1,94,000 of the shares offered to it, allotted on 28 January 2010, with the share certificates received on 10 February 2010; the balance of 1,19,624 shares went to other shareholders. As a result the assessee's holding fell from 4.98 per cent to about 3.17 per cent. The Assessing Officer treated the difference of Rs. 1,438 per share as inadequate consideration under s.56(2)(vii)(c), valuing the shares under rules 11U and 11UA, and added Rs. 27,89,02,160. The Commissioner (Appeals) confirmed it.
The appeal succeeded on this issue and the addition of Rs. 27,89,02,160 was deleted; the appeal is recorded as partly allowed only because ground 1 was not pressed and the stay application became infructuous. The Tribunal held that s.56(2)(vii)(c) is on its own terms capable of applying to a fresh allotment of shares - it rejected the argument that shares which come into existence only on allotment cannot be 'received' - but that where shares are allotted pro rata on the basis of existing holdings there is no scope for any property being received, because the value of the new shares is drawn from the existing holding and all that happens is an apportionment of that value over a larger number of shares (para 4.3). A disproportionate or non-uniform allotment would attract the provision, but only to the extent of the disproportion and after factoring in the fall in value of the existing holding. On the facts, the assessee's percentage holding having fallen, no addition arose (para 4.3). The Tribunal also recorded that the issue before it could not strictly be called a rights issue at all, since s.81 of the Companies Act 1956 does not apply to a private company and the scheme carried no right of renunciation.
The Tribunal first held that the property in question is within the provision. Shares are a specified property, and although a share does not exist before allotment, on allotment it comes into existence and is constructively received; the Tribunal drew that from Sri Gopal Jalan & Co. v. Calcutta Stock Exchange Association Ltd. [1963] 33 Comp. Cas. 862 (SC) and Khoday Distilleries Ltd. v. CIT [2008] 307 ITR 312 (SC). It then held that s.56(2)(vii) substitutes fair market value as the normative basis for receipts of property by an individual or Hindu undivided family, is an anti-abuse measure following the abolition of gift tax, and is not to be read down for hardship. The exemption of a proportionate allotment follows not from an exception but from the nature of the transaction: on a pro rata issue below fair market value the book value of the existing share falls by the amount that passes into the new share, so the shareholder receives only what he already owned, apportioned over more shares. The Tribunal used the illustration of exchanging a thousand rupee note for smaller notes when explaining why bonus shares are outside the provision, and applied the same premise to a proportionate further issue. It supported the point from Miss Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 (SC) and H. Holck Larsen v. CIT [1972] 85 ITR 285 (Bom.), and from s.55(2)(aa), which links the cost of the original and the additional financial assets. It distinguished K.P. Varghese, holding that the flaw the Supreme Court found in s.52(2) - that it created a fictional receipt - does not afflict s.56(2)(vii), where a receipt is established.
As long as, therefore, there is no disproportionate allotment, i.e., shares are allotted pro-rata to the shareholders, based on their existing holdings, there is no scope for any property being received by them on the said allotment of shares; there being only an apportionment of the value of their existing holding over a larger number of shares.
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Handle my notice → Ask a CA on WhatsAppNot on the proportionate part. Where further shares are offered to existing shareholders pro-rata to their holdings, there is only an apportionment of the value of the existing holding over more shares and nothing is received. Anything allotted beyond the proportionate entitlement is a different matter and can be taxed. This was decided by the ITAT (Income Tax Appellate Tribunal, Mumbai Bench 'A' - D. Manmohan (Vice-President) and Sanjay Arora (Accountant Member); AY 2010-11) and bears on section 56(2)(vii)(c), section 56(2)(x), section Rule 11UA of the Income Tax Act 1961. It is reported as [2014] 45 taxmann.com 176 (Mumbai - Trib.) / 148 ITD 260 (Mum.); 2014-TIOL-150-ITAT-MUM; IT Appeal No. 4887 (Mum.) of 2013 and SA No. 192 (Mum.) of 2013. This is the working rule for every below-value rights issue in a closely held company: measure the allotment against the proportionate entitlement, and only the excess is in play. It cuts both ways — the Tribunal also held that a fresh allotment is within the section even though there is no transfer, so the argument that nothing was 'received' because the shares did not previously exist is closed off. Where shares declined by other shareholders are picked up, that portion is where the exposure sits. If it applies to you, the first step is this: Work out the proportionate entitlement on the existing shareholding and set the number actually allotted against it; only the excess is capable of being taxed.
The assessee held 3,01,316 shares, about 4.98 per cent, of Dorf Ketal Chemicals India Pvt. Ltd. The company offered further shares at the face value of Rs. 100 each on a proportionate basis, the assessee's entitlement being 3,13,624 shares, roughly twenty-one for every share held, against a book value of Rs. 1,538 per share as on 31 March 2009. The assessee took up only 1,94,000 of the shares offered to it, allotted on 28 January 2010, with the share certificates received on 10 February 2010; the balance of 1,19,624 shares went to other shareholders. As a result the assessee's holding fell from 4.98 per cent to about 3.17 per cent. The Assessing Officer treated the difference of Rs. 1,438 per share as inadequate consideration under s.56(2)(vii)(c), valuing the shares under rules 11U and 11UA, and added Rs. 27,89,02,160. The Commissioner (Appeals) confirmed it. The matter was decided on 2014-03-12 by the ITAT (Income Tax Appellate Tribunal, Mumbai Bench 'A' - D. Manmohan (Vice-President) and Sanjay Arora (Accountant Member); AY 2010-11). On those facts the ITAT held as follows. The appeal succeeded on this issue and the addition of Rs. 27,89,02,160 was deleted; the appeal is recorded as partly allowed only because ground 1 was not pressed and the stay application became infructuous. The Tribunal held that s.56(2)(vii)(c) is on its own terms capable of applying to a fresh allotment of shares - it rejected the argument that shares which come into existence only on allotment cannot be 'received' - but that where shares are allotted pro rata on the basis of existing holdings there is no scope for any property being received, because the value of the new shares is drawn from the existing holding and all that happens is an apportionment of that value over a larger number of shares (para 4.3). A disproportionate or non-uniform allotment would attract the provision, but only to the extent of the disproportion and after factoring in the fall in value of the existing holding. On the facts, the assessee's percentage holding having fallen, no addition arose (para 4.3). The Tribunal also recorded that the issue before it could not strictly be called a rights issue at all, since s.81 of the Companies Act 1956 does not apply to a private company and the scheme carried no right of renunciation.
The Tribunal first held that the property in question is within the provision. Shares are a specified property, and although a share does not exist before allotment, on allotment it comes into existence and is constructively received; the Tribunal drew that from Sri Gopal Jalan & Co. v. Calcutta Stock Exchange Association Ltd. [1963] 33 Comp. Cas. 862 (SC) and Khoday Distilleries Ltd. v. CIT [2008] 307 ITR 312 (SC). It then held that s.56(2)(vii) substitutes fair market value as the normative basis for receipts of property by an individual or Hindu undivided family, is an anti-abuse measure following the abolition of gift tax, and is not to be read down for hardship. The exemption of a proportionate allotment follows not from an exception but from the nature of the transaction: on a pro rata issue below fair market value the book value of the existing share falls by the amount that passes into the new share, so the shareholder receives only what he already owned, apportioned over more shares. The Tribunal used the illustration of exchanging a thousand rupee note for smaller notes when explaining why bonus shares are outside the provision, and applied the same premise to a proportionate further issue. It supported the point from Miss Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 (SC) and H. Holck Larsen v. CIT [1972] 85 ITR 285 (Bom.), and from s.55(2)(aa), which links the cost of the original and the additional financial assets. It distinguished K.P. Varghese, holding that the flaw the Supreme Court found in s.52(2) - that it created a fictional receipt - does not afflict s.56(2)(vii), where a receipt is established. In the words reproduced by the source cited on this page: "As long as, therefore, there is no disproportionate allotment, i.e., shares are allotted pro-rata to the shareholders, based on their existing holdings, there is no scope for any property being received by them on the said allotment of shares; there being only an apportionment of the value of their existing holding over a larger number of shares."
It was decided by the ITAT on 2014-03-12 and is reported as [2014] 45 taxmann.com 176 (Mumbai - Trib.) / 148 ITD 260 (Mum.); 2014-TIOL-150-ITAT-MUM; IT Appeal No. 4887 (Mum.) of 2013 and SA No. 192 (Mum.) of 2013. Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere. A Tribunal decision binds the assessing officer and the Commissioner (Appeals) within that Tribunal's jurisdiction, and is persuasive before other benches. It is not binding on a High Court, and a contrary co-ordinate bench decision will be argued against you, so check whether the point has been taken the other way before you build a reply around it. On section 56(2)(vii)(c), section 56(2)(x), section Rule 11UA, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It cuts both ways and is cited by both sides. The appeal succeeded on this issue and the addition of Rs. 27,89,02,160 was deleted; the appeal is recorded as partly allowed only because ground 1 was not pressed and the stay application became infructuous. The Tribunal held that s.56(2)(vii)(c) is on its own terms capable of applying to a fresh allotment of shares - it rejected the argument that shares which come into existence only on allotment cannot be 'received' - but that where shares are allotted pro rata on the basis of existing holdings there is no scope for any property being received, because the value of the new shares is drawn from the existing holding and all that happens is an apportionment of that value over a larger number of shares (para 4.3). A disproportionate or non-uniform allotment would attract the provision, but only to the extent of the disproportion and after factoring in the fall in value of the existing holding. On the facts, the assessee's percentage holding having fallen, no addition arose (para 4.3). The Tribunal also recorded that the issue before it could not strictly be called a rights issue at all, since s.81 of the Companies Act 1956 does not apply to a private company and the scheme carried no right of renunciation. It arises in Gifts, Shares & Angel Tax matters, on section 56(2)(vii)(c), section 56(2)(x), section Rule 11UA of the Income Tax Act 1961, and was decided by Income Tax Appellate Tribunal, Mumbai Bench 'A' - D. Manmohan (Vice-President) and Sanjay Arora (Accountant Member); AY 2010-11. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Where shares declined by other shareholders were re-allotted to you, treat that block separately in the reply rather than defending the whole allotment as one. Do not argue that a fresh allotment is outside the section because there is no transfer — the Tribunal rejected that, holding that 'receipt' is wider than transfer and that a share comes into existence only when it is allotted. Keep the offer letter, the shareholding pattern before the issue and the allotment return on file to prove the pro-rata basis.
Superseded by amendment. The clause construed, s.56(2)(vii)(c), applies to receipts before 1 April 2017; for later receipts the operative provision is s.56(2)(x). Two things about later treatment. No decision has been found recording this order as followed in terms. It was cited to the Gujarat High Court in Pr. CIT v. Jigar Jashwantlal Shah [2023] 154 taxmann.com 568 / [2024] 460 ITR 628, decided 28 August 2023 (Biren Vaishnav and Bhargav D. Karia, JJ.), but appears only among the cases referred to, at para 9, and not in that judgment's case review. More important, the High Court took a wider view than this order does and one that is inconsistent with its first limb. It held that s.56(2)(vii)(c) requires property to pre-exist and to be 'received from any person', that the allotment of new shares is a creation of property and not a transfer, and that the provision therefore does not apply to a fresh issue at all (paras 17 to 19). This Tribunal, by contrast, held the provision per se applicable to a fresh allotment and rested the assessee's success on the pro rata character of the allotment. So in Gujarat the assessee has a wider answer than this decision gives, and the corollary this decision draws - that a disproportionate allotment is caught - does not sit easily with the High Court's reasoning. The High Court also held that shares received on renunciation by a wife and father are outside the provision because they are relatives. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
Two corrections of substance. The appeal number is IT Appeal No. 4887 (Mum.) of 2013, together with SA No. 192 (Mum.) of 2013, which settles the disagreement this entry previously recorded. And the transaction was the reverse of what was recorded here: the assessee took up only 1,94,000 of the 3,13,624 shares offered to it, the balance of 1,19,624 went to other shareholders, and its holding fell from 4.98 per cent to about 3.17 per cent - which is why no disproportionate allotment arose. Three points of use. The Tribunal was careful to say that the issue could not strictly be called a rights issue, because s.81 of the Companies Act 1956 does not apply to a private company and the scheme carried no right of renunciation, so describe it as a proportionate further issue. The provision was held applicable in principle to a fresh allotment; the assessee won on the pro rata character of the allotment, not on the shares not pre-existing. And the order is on s.56(2)(vii)(c), which applies to receipts before 1 April 2017; for later receipts the provision is s.56(2)(x). Note finally that the Gujarat High Court in Pr. CIT v. Jigar Jashwantlal Shah [2024] 460 ITR 628 has since held that the provision does not reach a fresh issue at all, a wider answer that does not rest on this reasoning. The Tribunal's corollary that a disproportionate allotment attracts the provision was not applied to any figure here, since none arose on the facts, so it is reasoning rather than decision. How that corollary survives the Gujarat High Court's wider view that a fresh issue is outside the provision altogether has not been resolved by any decision found. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal succeeded on this issue and the addition of Rs. 27,89,02,160 was deleted; the appeal is recorded as partly allowed only because ground 1 was not pressed and the stay application became infructuous. The Tribunal held that s.56(2)(vii)(c) is on its own terms capable of applying to a fresh allotment of shares - it rejected the argument that shares which come into existence only on allotment cannot be 'received' - but that where shares are allotted pro rata on the basis of existing holdings there is no scope for any property being received, because the value of the new shares is drawn from the existing holding and all that happens is an apportionment of that value over a larger number of shares (para 4.3). A disproportionate or non-uniform allotment would attract the provision, but only to the extent of the disproportion and after factoring in the fall in value of the existing holding. On the facts, the assessee's percentage holding having fallen, no addition arose (para 4.3). The Tribunal also recorded that the issue before it could not strictly be called a rights issue at all, since s.81 of the Companies Act 1956 does not apply to a private company and the scheme carried no right of renunciation.
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