Taxation of Capital Receipts - Section 56(2) and Section 68 of the Income-tax Act, 1961 - By: Yogesh A. Thar Section 56(2) [Gifts as Income] Gifts are token of love, admiration, respect or appreciation But the Taxman sings a different song. What s love got to do with it?, he asks. Till 1998 Donor based Gift Tax. Abolished, as Revenues were less than Administrative costs. 2004 Donee based Gift Tax introduced Gifts = Capital Receipt not income - But purpose prevent money laundering / anti-evasion Therefore such provisions Courts will not strike down as unconstitutional. Section 68 already on statute tax unexplained cash credited. But considered too weak to deal with bogus capital building & money laundering Therefore, Finance (No.2) Act, 2004 amend to S.56 Gifts as income A.Y. 2005 06 amended to S.2(24) Income amended to S. 56(2) (v) Receipts > 25,000 w/o consideration By Individual & HUFs Receipts of sum of money only Certain exemptions provided relatives/marriage etc. Therefore Gifts to Cos, Firms - not covered Gifts in kind - not covered Not clear whether Rs 25000 per year Or Aggregate in lifetime? Or Per gift Rs 25000 A. Y. 2007-08 - amendment to Section 56(2) - Cl. (v) omitted. New Cl. (vi) introduced Receipts > 50,000 w/o consideration - in a P.Y. Same loop holes: N.A. to Companies, Firms N.A. to Gifts in Kind A. Y. 2010-11 to be precise post 1.10.2009 56(2) (vii) introduced 1
Receipts by Individual or HUFs Sum of Money Immovable Property Property Other than immovable property >50,000 in a P.Y (b) & (c) w/o consideration w/o consideration for inadequate w/o consideration for inadequate consideration >50,000 consideration [See (b) below] [See (c) below] Stamp Duty Valuation Removed by F.A. 2010 >50,000 [See (a) below] w.r.e.f 1.10.2009 [Double Taxation 50e + 56] (a) Immovable property w/o consideration therefore no C.G. S. 47 exempt (b) & (c) - Property defined: (i) Immovable property being land or building (ii) Shares and securities (iii) Jewellery (iv) Archeological collections (v) Drawings (vi) Paintings (vii) Sculptures (viii) any work of art (ix) Bullion ------------------------------------------------------------------------------------------------------------------------------------- Therefore, not included motor case - laptops / computers Aircraft - electronic items Yatch - silver /gold utensils ------------------------------------------------------------------------------------------------------------------------------------- Exempted transaction Receipts from relatives Occasion of marriage Will / inheritance Gift in contemplation of death From local authority Trust / hospital etc. u/s. 10(23C) Trust u/s. 12AA 2
56 (2) (viia) Receipt by Firm After 1-6-2010 Receipt by closely held Co. Subject matter shares of a Closely held Company Receipt w/o consideration FMV 50,000 for inadequate consideration (FMV Consideration) >50,000 Exemptions 47 ( via) : amalgamation of FC1 with FC 2 47 (vic) : demerger of FC1 into FC2 47 (vicb) : Business reorganization of co-operative bank 47 (vid) : Issue of shares by Resulting Company in a demerger 47 (vii) : Amalgamation ------------------------------------------------------------------------------------------------------------------------------------------ Rule 11UA How is FMV determined (a) (b) (c) Jewellery Archeological collections Shares & Drawings, paintings, sculptures, Securities (PTO to page 4) Works of art. -Open market price - Open market price -Purchase from registered - Purchase from Regd. Dealer - -Dealer [S.T. reqd.] - Invoice value = Invoice value - Valuation report of Regd.valuer -Valuation Report of Regd. Valuer 3
Shares & Securities (a) (b) (c) Quoted Unquoted Equity Unquoted Pref.shares Shares other securities. Purchase through S. E. A L X PV Transaction value as PE recorded in S.E. Otherwise: Assets Lowest price of shares Book value On the Val. Dt. on any Less- Adv. Tax recognised. S.E. Less- P & L Dr. Bal. Or Last quoted. Liabilities. If no quote on the val date Total liability. Less. Paid up Equity share cap. Less: Prop.Div. Less : Res. Less: P & L Cr.Bal. Less: Prov.for tax Adv.tax in Excess over tax payable Less: Prov. For Tax Lia. Less: Cont. lia.(other than Arrears of div. on Pref.shares) Issues on Sec. 56(2) 1). Rs.50,000 limit : How to apply in case of gift to minors? Parent receives Parent receives Gift Gift of of Rs.30,000 clubbing u/s.64 Minor receives gift of Rs.25,000 Question: Take total of both or apply exemption independently? Answer: 64 (1A) In computing income tax of any individual there shall be included all such income as arises or accrues to the minor child. Therefore, there should be income accruing to minor child Income u/s. 2(24) r.w. 56(2) = amount in excess of Rs.50,000/- 4
If < 50,000; not income u/s.56(2) Therefore: no clubbing Answer: apply 50,000 limit separately to minor & parent 2) Scholarships received to meet the cost of education Exempt u/s.10(16) Not taxable any way. 3) Can a loan transaction be covered u/s.56(2)(vii)? Department has tried to do this in some cases Answer: NO Loan [receipt coupled with an obligation to repay] Therefore: Not a receipt w/o consideration. Therefore: not covered by S.56 ITAT Mumbai: ` Chandrakant H. Shah v. ITO, ITA No. 3966/M/2008 Loan not covered u/s. 56(2) Loan can be examined u/s.68 Just, since 68 conditions are satisfied, 56(2) cannot be applied [Pity - that such issues have to be travel upto ITAT] ----------------------------------------------------------------------------------------------------------------------------------------- 4) Can sec. 56(2) apply to receipt of shares etc. by an AOP? Answer: (vii) - Individual/HUF (viia) - Firm / Company Therefore NA to AOP Q:- shares registered in the names of individual members of AOP Therefore to see registered holder or beneficial holder? Q: - AOP is mere creature of IT Act. Not person under general law. Therefore receipt is by Individual? Ans: - Even Firm / HUF cannot be members of a Company. Shares required in names of Partners/Karta. 187C Decl. is filed. 5
AOP separate person for tax. Therefore cannot be ignored. Documentation important. 5) Amount spent by HUF on its members whether covered? Q:- Ans: - HUF gives a cheque to the member for education fees (instead of paying directly) Amount received from relative is exempt. relative - when HUF receives from member Finance Act, 2012 solved the anomalyexempted But relative in case of individual does not include HUF of which he is a member Ans: - NO 56(2) NA duty of Karta to spend money towards wellbeing/welfare of its family members not gift. Not w/o consideration inherent right of a member and duty of the karta therefore 56(2) N.A. S.10 (2) exempts receipts from income of HUF. * -------------------------------------------------------------------------------------------------------------------------------- 6) Receipt by Trustee under a Trust deed Trustee receives with an obligations Fiduciary capacity Therefore not w/o consideration Obligation recipient freedom to appropriate himself Therefore cannot apply 7) Receipt by beneficiaries from the Trustee Exemption for receipt from charity Trust Q: Pvt Trust? View: Mere realization of its rights under Trust Deed Therefore not a receipt Therefore NA May be litgious If relative of settler safe If Trust is ignored yet no tax ------------------------------------------------------------------------------------------------------------------------------------------ 6
8) Rights shares Dhanubhai Kapadia - MV of Original shares = COA of Right Shares Therefore rights is not equal to w/o consideration & rights is not equal to for inadequate consideration Since gain is equal to sacrifice 9) Bonus shares Capitalisation of profits Effect same as Rights Decrease in MV of original Shares = Cost of Bonus Shares Therefore: spread over theory Therefore not without consideration And not inadequate consideration 10) When partner transfer his individual asset into firm as capital contribution [50D?] Sunil Siddharthbhai 156 ITR (SC) consideration not determinable Therefore, computation fails 45(3) - amount recorded in books = consideration - C. G. only Q: 56(2) recipient firm 56(2)(viia) shares in an unlisted company Transfer @ cost recorded in books @ cost - Therefore 45(3) No capital gain (or indexed cost) But Firm receiving @ cost. If cost < 11UA value can firm be taxed u/s. 56(2)(viia). w/o consideration for inadequate consideration Now, Sunil Siddharthbhai consideration cannot be determined Therefore, cannot say without consideration or inadequate Consideration. Amount recorded in books = consideration only for the purposes of S.48 r.w.s 45(3). It is not consideration for S.56(2). 7
50D introduce d by Finance Act, 2012 for the purpose of computing income chargeable under the head Capital Gains, FMV= consideration Therefore 50D NA for 56(2) 11UA rules are for FMV and not for consideration Therefore 56(2) mechanism fails Therefore 56(2) N. A. for firm in such cases. 11) Buyback of shares E.g. Unlisted company buys back its own shares @ < 11UA value what happens? BUYBACK 77A 391 Scheme Reduction u/s.100 46A capital gains - 2(22) + 46A Recipient = Company Therefore 56(2)(viia)? 77A(7) Co. shall extinguish and physically destroy the securities so bought back <7 days - receives - By buyback from 1 Shareholder at less than FV - Company s liability to remaining Shareholders - Therefore, gain from buyback is offset by sacrifice towards other Shareholders - Therefore no 56(2) to the company 12) Insurance claims received - Contract of indemnity - Therefore not without consideration 8
13) Compensation for personal injury from Government - L. A. exempt - Govt. not mentioned - BUT - such compensation Inherent duty of the State to protect its citizens Compensation for a personal loss/injury It is not a receipt without consideration Since, there is a loss /injury But better - if clarified. Cir No.5/2010 dt. 3.6.2010 refers to 56(2) as anti abusive provision. Therefore, spirit of Sec. - cannot apply to such payment. 14) Family settlement - cases under G. Tax Act no transfer - cases under I. Tax Act - no C.G. Tax - Rationale - anticident title If this logic applies not a receipt Since I was always the real owner Therefore should not apply - Litigatious 9
56(2)(viib) If C > Face value, C FMV= Deemed income of the Company Any Person Given Exceptions: (Resident) Company is VCU & giver is VCC/VCF Receipt from notified persons Issue of Shares Consideration for issue of shares (c) Recipient Company (Closely Held company) How to compute FMV? (i) To be determined in accordance with prescribed methods OR (ii) Company may substantiate to the A.O. value based on : Assets, including intangible assets ( GW, KH, Pat. CR, TM, L.F) HIGHER Q: Why will a Company substantiate higher value? It will try to substantiate lower value as compared to prescribed method. Issue: Corporate reorganization Eg. Demerger Same S/H Need not do a fair valuation Say 1:1 SC 10 DR 20 Assets. 100 Liab. 70 (Risk) 10
Therefore should exempt all cases of demerger/amalgamation else litigation. SECTION 68 Any sum found credited in Books of Account Maintained for any P.Y. A offers no explanation Nature Source OR Explanation offered is not satisfactory Sum so credited may be charged to Income Tax as income of that P.Y. New proviso w.e.f. 1.4.13 (A.Y. 13-14) Company [closely held] Share Appn. Money Share Capital Share premium OR Any such amount by whatever name called Explanation given by assessee deemed to be NOT satisfactory UNLESS Person (being a resident) also offers explanation about (a) Nature (b) Source AND Such explanation is found satisfactory. NA. if investor is VCF/VCC 10(23 FB) Lovely Exports 216 CTR 195(SC) No addition in hands of Co. Can make additions in hands of S/H if his source is not satisfactory 11
Steller Investments 115 TAXMAN 99 (SC) Principles (Settler) Primary onus on assessee Assessee not to establish source of source If primary onus is discharged onus shifts to Dept. AO to assess S/H of reqiored. Issues: 1) Co.- S/H Y no explanation offered about source of Y Q. Addition in hands of CO X as per amendment. But can addition be made also in hands of Y? 2) Proviso applies to closely held companies But main provision combines to apply to all. Therefore, Identity / Genuiness/Credit worthiness should be proved even in case of listed companies. (Only source of source need not be proved). 2) Applies to Share Appn./share capital/share premium or any such amount by whatever name called Therefore, only in the nature of capital not in the nature of Debt/loan/Deb.etc. 3) Person being a resident Even a widely held company Or a Govt. Corporation Or a Bank Or a public sector company Or P.E. Funds etc. 5(a) Explanation shall be deemed to be unsatisfactory UNLESS 12
Person being a resident also offers. Therefore, Q: What if the person is a NR? Always deemed unsatisfactory? OR Proviso NA if shareholder is a NR? 5(b) FCCB Issue Depositry Depositry receipts Several holders Not known Dept. makes additions Cannot genuine And not affect these cases 6. N. A. to capital introduced in: a) Partnership firm, b) LLP c) Widely held company 7. Opinion of A.O. explanation is not satisfactory - Opinion objective and not subjective - Opinion after proper enquiry - Enquiry reasonable and just - Principles of natural justice to be followed. 13
SECTION 115 BBE New Section w.e.f. A.Y. 2013-14 Tax rate flat rate 30% Initial basic exemption N.A. Effect If source explained as Tiffin income/tuition income Below taxable limit A.O. not satisfied Now addition u/s.68 Pay 30% flat rate. 14