BCAS Direct Tax Study Circle Meeting 5 August 2019 Angel ...€¦ · BCAS DT Study Circle –Angel...

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BCAS Direct Tax Study Circle Meeting – 5 August 2019

Angel Taxation

Mahesh G Nayak

1CNK

Historical background of section 56(2)(viib)

• Prior to introduction of the section, amount received by a company towards its share

capital was not considered as income under the Act

• Section 68 of the Act required the company to explain the source of funds in respect of the

share capital received

• Introduced in the Finance Act, 2012 as a measure to deter the generation and use of

unaccounted money (as per FM speech)

• Seeks to tax excess money received by a company on issue of shares

BCAS DT Study Circle – Angel Taxation 2 July 2019

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Section 56(2)(viib)

where a company, not being a company in which the public are substantially interested, receives, in anyprevious year, from any person being a resident, any consideration for issue of shares that exceeds theface value of such shares, the aggregate consideration received for such shares as exceeds the fair marketvalue of the shares:

Provided that this clause shall not apply where the consideration for issue of shares is received –(i) by a venture capital undertaking from a venture capital company or a venture capital fund or a

specified fund; or(ii) by a company from a class or classes of persons as may be notified by the Central Government in this

behalf.

Provided further that where the provisions of this clause have not been applied to a company on accountof fulfillment of conditions specified in the notification issued under clause (ii) of the first proviso and suchcompany fails to comply with any of those conditions, then, any consideration received for issue of sharethat exceeds the fair market value of such share shall be deemed to be the income of that companychargeable to income-tax for the previous year in which such failure has taken place and, it shall also bedeemed that the company has under reported the income in consequence of the misreporting referred toin sub-section (8) and sub-section (9) of section 270A for the said previous year.


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Section 56(2)(viib)

Explanation – For the purposes of this clause, -

(a) the fair market value of the shares shall be the value –(i) as may be determined in accordance with such method as may be prescribed, or(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on

the value, on the date of issue of shares, of its assets, including intangible assets beinggoodwill….or any other business or commercial rights of similar nature,

whichever is higher;

(aa) ‘specified fund’ means a fund established or incorporated in India in the form of a trust or a companyor a limited liability partnership or a body corporate which has been granted a certificate ofregistration as a Category I or a Category II Alternative Investment Fund and is regulated under theSecurities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012 made underthe Securities and Exchange Board of India Act, 1992;

(ab) ‘trust’means a trust established under the Indian Trusts Act, 1882 or under any other law for the timebeing in force;

(b) ‘venture capital company’, ‘venture capital fund’ and ‘venture capital undertaking’ shall have themeanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause(23FB) of section 10.


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Non-resident issuer company


• B Ltd, a resident of UK, issues shares to A

Ltd, an Indian company

• B Ltd does not have its POEM in India nor

does it have any other activities in India

• Would the provisions of section 56(2)(viib)

apply to B Ltd?

• Definition of company u/s 2(17) includes

any body corporate incorporated by or

under laws of country outside India

• It is income under section 2(24) as

specifically covers income u/s 56(2)(viib)

• Is it accruing or arising in India

A Ltd

B Ltd

India

UK

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Company in which public are substantially interested


Company in which 40% or higher stake held by Government and/or RBI

Section 25 company (Section 8 company under the new Companies Act)

Company having no share capital and declared by CBDT as such

Mutual benefit finance company

Company in which 51% voting power is held by one or more co-op societies

Company listed on a recognised stock exchange on the last day of previous year

Public limited company where atleast 50% of the voting power is held by a corporation established by a Central, State or Provincial Act

Public limited company where atleast 50% of the voting power is held by a listed company or a WOS of listed company i.e. Second level subsidiary

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• A Ltd and B Ltd are resident Indian

companies, listed on the BSE as on 1st April

2019

• B Ltd issues shares to A Ltd on 2nd July 2019

• B Ltd is delisted on 1st January 2020

• Is B Ltd a company in which public are

substantially interested?

• Shares of A Ltd are listed - relevant?

• What if on the date of the transaction B Ltd

is not a listed entity but it is listed on 31st

March 2020?

A Ltd

B Ltd

When does one see the listing condition? On the date of the transaction or on the last day of the previous year

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• A Ltd and B Ltd are resident Indian

companies, whose equity shares are listed

on the BSE

• B Ltd issues preference shares to A Ltd

• Preference shares are unlisted

• Is B Ltd a company in which public are

substantially interested?

• What if preference shares of B Ltd are

listed and the shares issued are equity

shares?

A Ltd

B Ltd

Which shares need to be listed – equity, preference or the shares being issued

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From a person being a resident


• A Ltd, incorporated in UK having its POEM

in India, subscribes to the share capital of B

Pvt Ltd


apply?

• Impact of FEMA Regulations regarding

valuation in case of FDI

A Ltd

B Pvt Ltd

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Receives in any previous year


• A Ltd subscribes to the share capital of B

Pvt Ltd

• The share application money is received by

B Pvt Ltd on 31st March 2019 but the

shares are issued to A Ltd on 1st May 2019

• Which year would the provisions of section

56(2)(viib) apply?

A Ltd

B Pvt Ltd

When is section 56(2)(viib) triggered – on receipt of share application money or on issue of shares

Cash – March 2019Shares – May 2019

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Consideration


• B Pvt Ltd issues CCPS to A Ltd on 1st April

2019

• Such CCPS are to be converted into equity

shares after a period of 3 years from the

date of issue

• Would the issue of CCPS be subject to the

provisions of section 56(2)(viib)?

• Would the conversion of CCPS into equity

shares be subject to the provisions of

section 56(2)(viib)?

• If yes, when does one need to

evaluate the provisions of the section

– on issue of CCPS or on conversion

A Ltd

B Pvt Ltd

What about share warrants?

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Issue of shares at discount


• B Pvt Ltd issues shares to A Ltd at par i.e. at

INR 10 per share

• The fair market value of B Pvt Ltd as on the

date of issue as computed under Rule

11UA is INR 8 per share


apply?

A Ltd

B Pvt Ltd

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Exemption from the provisions of section 56(2)(viib)


Amount received by

Venture capital undertaking from Category I or Category II

AIF

Company from class of person or persons as may be

notified

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Exemption in the case of investment by certain AIF


Category I AIF

• Venture Capital Funds

• Social Venture Funds

• SME Funds

• Infrastructure Funds

Category II AIF

• Private Equity Funds

• Real Estate Funds

• Debt Funds

Category III AIF

• Hedge Funds

• Other AIFs which undertake diverse trading strategies involving derivatives

The Fund needs to be registered as a Category I or Category II AIF under the SEBI AIF Regulations and needs to be incorporated in India

Investment needs to be in a venture capital undertaking i.e. a domestic unlisted company engaged in the business of providing services, production or manufacture of article or things but not in the business of NBFC, gold financing, activities not permitted under the industrial policy

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Investment by AIF


• B Pvt Ltd has received share subscription

money from A Ltd. in May 2019

• The shares are issued by A Ltd in July 2019

• A Ltd was registered as a Category I AIF in

June 2019

• Would the investment be exempt from the

provisions of section 56(2)(viib)?

A Ltd

B Pvt Ltd

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Exemption for investment in start-up


Particulars Notification dated 11 April 2018

Notification dated 19 February 2019

Period for recognition as start-up

• 10 years in case of start-up in the bio-technology sector

• 7 years in all other cases

10 years

Turnover limit (for any financial year) since incorporation

INR 25 crore INR 100 crore

Business Working towards innovation, development or improvement of products or process or services, or if it is a scalable business model with a high potential of employment generation or wealth creation

Working towards innovation, development or improvement of products or process or services, or if it is a scalable business model with a high potential of employment generation or wealth creation

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Exemption for investment in start-up


Particulars Notification dated 11 April 2018

Notification dated 19 February 2019

Aggregate paid up share capital and share premium (after the present issue of shares) limit

INR 10 crore INR 25 crore (excluding investments by VCF and non-residents or a listed company whose networth exceeds INR 100 crore or the turnover exceeds INR 250 crore)

Conditions for investor • Average returned income of INR 25 lakh or more for the preceding 3 FY; or

• Net worth of INR 2 crore or more as on last date of preceding FY

None

Other conditions • Start-up has obtained a report from merchant banker under Rule 11UA

• Startup has been recognised by DPIIT

• Certain investment restrictions

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Investment restrictions for start-up


Building or Land, other than occupied for its business or held as stock-in-trade or for the purpose of renting

Loans and advances, other than those extended in ordinary course of business where lending of money is a substantial part of its business

Capital contribution made to another entity

Shares and securities

Motor Vehicle whose cost exceeds INR 10 lakh, other than those used in the business of plying, hiring or leasing or as stock-in-trade

Jewellery, other than held as stock-in-trade

Archaeological collection, drawings, paintings, sculptures, any work of art or bullion

A Start-up cannot for a period of 7 years from the last date of the FY in which the premium was received, invest in the following assets:

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Consequence on non-compliance of restrictions


• B Pvt Ltd, registered start-up has issued

shares to A Ltd. on 20 February 2019

• It has availed the benefit of the notification

dated 19 February 2019

• On 1 May 2019, it provides a loan to its

employees of INR 1 lakh

• What would be the consequence for the

breach of the condition as prescribed in

the notification?

A Ltd

B Pvt Ltd

Would the answer be different if the or if the loan was provided on 1 March 2019 or if the shares were issued in December 2018?

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Computation of FMV – Rule 11UA


Issue of Preference

Shares

FMV as valued by Merchant Banker

or CA

Issue of equity shares (option of

assessee)

Specified formula (Net Asset Value)

Discounted Cash Flow as

determined by a Merchant Banker

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Computation of FMV – Specified formula


FMV = A – L x PVPE

A = Book value of assets as appearing in balance sheet(-) TDS/TCS/ Advance tax(-) amount claimed as refund(-) any amount shown in balance sheet as asset including unamortised value of deferred expenditure which does not represent value of any asset

L = Book value of liabilities as appearing in balance sheet(-) Amount of paid up capital in respect of equity shares(-) Amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company(-) Reserves and Surplus (except when set apart towards depreciation)(-) Provision for tax(-) Provision for unascertained liabilities(-) Contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares

PE = Total amount of paid up equity share capital

PV = Paid up value of such shares

In this case, the FMV would not be adjusted to take into account the fair value of immovable property or shares and securities held

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Valuation method


• B Pvt Ltd, has issued shares to A Ltd. at a premium of INR 140 per share (face value per

share is INR 10)

• The Net Asset Book Value is INR 20 per share

• The value as per DCF is INR 155 per share

• What would be the implications under section 56(2)(viib)?

Can the tax authorities impose a particular method on the assesse?

What would one need to justify for DCF valuation? Whether the projections can be compared with actual and additions made accordingly?

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Interaction of section 56(2)(viib) with section 56(2)(x)


• B Pvt. Ltd is an Indian company, having 2

shareholders, Ms. A and her daughter Ms.

A Jr.

• Ms. A has infused further funds in B Pvt Ltd

at an unrealistic premium

• Can the tax authorities tax such premium if

it is above the FMV as per Rule 11UA

A

B Pvt Ltd

A Jr

Chennai ITAT in the case of Vaani Estates (P) Ltd (98 taxmann.com 92)

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Interaction of section 56(2)(viib) with section 56(1)


• B Ltd is an Indian company, a WOS of A Ltd.

• A Ltd is a WOS of a listed company

• Therefore, B Ltd is a company in which the

public are substantially interested

• B Ltd issues further shares to A Ltd at an

unrealistic premium

• Can the tax authorities tax such premium if

it is above the FMV as per Rule 11UA

A Ltd

B Ltd

Hyderabad ITAT in the case of Apollo Sugar Clinics Ltd (105 taxmann.com 254)

24CNK

Thank You

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BCAS Direct Tax Study Circle Meeting 5 August 2019 Angel ...€¦ · BCAS DT Study Circle –Angel...

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