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Bombay Chartered Accountants Society

Taxation of securities

Presentation by
Yogesh Thar July 11, 2018
1. Business Income v. Capital Gains
Relevant Judicial Pronouncements and Legislations
 Tests laid down in:
 Instruction No. 1827 dated August 31, 1989
 Circular no. 4/2007 dated June 15, 2007
 Circular no. 6/2016 dated February 29, 2016
 CBDT Letter F. No. 225/12/2016 of May 2016

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Tests summarised
 Considering the judicial pronouncements, instructions and circulars above, the tests are
summarised as under…:
 Past Assessment Records
 Treatment in the books of account (i.e. whether shown as investment or as stock-in-trade)
 Method of valuation
 Nature and Quantum of purchase and sale
 Ratio between purchase and sales
 Period of Holding

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Tests summarised (contd…)
 …Considering the judicial pronouncements, instructions and circulars above, the tests
are summarised as under:
 Frequency, continuity and regularity of transactions
 Motive or intention behind acquisition / sale of securities
 Source of Acquisition – Whether from owned or borrowed funds
 It is possible to have two portfolios - one for investment and the other for stock-in-trade
 Any act subsequent to the purchase thereby making it more readily resalable
 Any act prior to purchase making showing a design or purpose

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Case Laws Summary
 Chart demonstrating the facts in various case laws numerically and the judgement thereof
Sr. Criteria Nailesh Pargro S.K. Dhiraj Bharat Kunverji Hriday Naishadh v.
no. Dalal Investment Finance Kenia Kenia Kenia Nailesh Vachharajani
Pvt Ltd Dalal
Period of over 6
1 holding months (avg) 1 to 9 months 106 days 107 days 116 days 124 days over 6 months 2 to 5 months
No. of scripts
2 purchased 41 79 51 129 142 213 25 2,00,066 shares
No. of scripts traded
3 sold 49 79 49 105 168 173 25
Value of
purchases (Amt
4 in lakh) 250.38 368.24 79.16 153.70 272.94 2008.45 21.38 104.33
Value of sales
5 (Amt in lacs) 432.72 487.94 79.35 131.47 369.83 1059.95 23.90 117.81
No. of purchase
6 days 49 56 315 261 236 177 222 transactions

7 No. of sale days 68 45 312 240 202 162

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Case Laws Summary (contd…)
 Case laws referred to in the Chart:
 Nailesh Dalal (ITA No. 3337/M/2009)
 M/s Pargro Investments Pvt. Ltd. v. ITO (ITA No. 829/M/2010,ITA No.637/M/2010)
 M/s S.K. Finance v. Dy. CIT (ITA No.6190/M/2008)
 Bharat Kunverji Kenia v. ACIT (130 TTJ 86)
 Kunverji Nanji Kenia v. ACIT (43 SOT 87)
 ITO v. Hriday Nailesh Dalal (ITA No. 3469/M/2009)
 ACIT v. Naishadh V. Vachharajani (ITA No.6429/M/2009)

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Impact of Circular No. 6/2016 dt. 29.2.2016 and F. No.
225/12/2016-ITA-II dt. 2.5.2016
Types of securities Listed Unlisted
Treatment by Assessee Stock in Capital Asset
in ROI: Trade
Holding Period - Less than 12 More than 12 Irrespective of
months months period of holding
Taxable as Business To decide based Capital Gains – Capital Gains
Income on established but consistency
tests desired

 Bogus transactions – to deal on merits. Above circular not applicable ;


 Transfer of unlisted shares requiring lifting of corporate veil ;
 The transfer of unlisted shares is made along with the control and management of underlying
business

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Transfer of “Control and Management” alongwith the
shares
 Ramnarain Sons (P.) Ltd. v. CIT (41 ITR 534) (SC)
 If the shares were acquired for obtaining control over the managing agency of the Mills, the
fact that the acquisition of the shares was integrated with the acquisition of the managing
agency did not affect the character of the acquisition of the shares
 Shares acquired formed a capital asset
 The loss suffered by sale of some of those shares in the year of account is a capital loss

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Bonus Stripping
 Dividend stripping is covered under specific s. 94(7). However, Bonus stripping not
covered
 Intention at the time of acquisition – A vital factor in determining the nature of
investment – Whether capital asset or stock-in-trade
 Acquisition of shares with a view to sell them post issue of bonus – To claim STCL
 Bonus shares sold after 12 months amounts to LTCG (earlier exempt - Now subject to
10% tax)
 Overall – Commercial gain
 Can the Department treat the transaction of acquisition as “business” on the ground
that the intention at the time of purchase is to sell?

Can GAAR provisions be invoked ?

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Finance Act, 2018 – ICDS VIII
 ICDS VIII - Securities held as stock-in-trade to be valued at lower of cost or NRV - To
determine category-wise (For other than Banks)
 Held - Contrary to Accounting Standards

 Pre-amended s. 145A - non-obstante clause

 Delhi HC - Held ICDS ultra vires

 S. 145A substituted by FA 2018

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S. 145A

 Amendment to s. 145A
 Non-obstante clause removed
 Section itself provides for valuing inventory of securities category-wise
 Unlisted / thinly traded securities to be valued only at actual cost (NRV not permitted)
 Banks to value inventory of securities as per RBI guidelines

 Affected entities:
 NBFCs
 Other traders in shares and securities
 All holdings of unlisted / thinly traded shares / securities

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S. 145A (contd…)
 Units of mutual funds held as S-I-T
 Securities “not listed on BSE”
 Hence, covered under the mischief of this amendment

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S. 145A (contd…)

 Illustration of impact: NRV has to be done category wise not individual asset wise.

Individual Security Cost NRV Lower


Company P 150 20 20
Company Q 150 45 45
Company R 150 15 15
Company S 150 300 150
600 380 230

Valuation (A.S.) 230


Valuation (under 145A) 380

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2. Ind-AS – Impact on taxation of transaction in
securities
Investment in Units of Equity Mutual Fund
 AS 13: Value long term investments at cost - Long term diminution to be recorded at
NRV
 Ind AS 109:
 Financial Assets measured at Amortised Cost:
• Hold FA to collect contractual cash flows
• Contractual cash flows = Principal + Return
 Financial Asset measured at FVTOCI
• Hold FA to collect contractual cash flows + Sale
• Contractual cash flows = Principal + Return
 Other Financial Assets – Measured at FVTPL (Exception: Equity instruments – Option to
FVTOCI)
 EAC Opinion: Equity Mutual Fund Units are NOT Equity instruments. Hence, FVTPL
is mandatory
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Purpose of MAT
 Hon’ble Finance Minister’s speech explaining the rationale for introducing s.
80VVA in the year 1983, vide Finance Act, 1983 -
 “Hon’ble Members must be aware of the phenomenon of companies which are flourishing,
but are paying no tax at all, or only nominal tax. This is largely due to these companies
availing of the tax incentives and concessions available under the provisions of the Income-
tax Act. It has been a matter of concern to us that our tax system several highly profitable
companies are able to reduce their tax liability to zero even though they continue to pay high
dividends. It seems reasonable that profitable and prosperous companies should contribute
at least a small portion of their profits to the national exchequer at a time when other and
less better off sections of society are bearing burden. I, therefore, propose to provide that
fiscal incentives and concessions shall not absorb more than 70 per cent of the profits. This
would secure that companies pay a minimum tax, on at least 30 per cent of their profits.”

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Purpose of MAT (contd…)
 Para 83 of the Explanatory Memorandum to the Finance Bill, 1983
 “With a view to securing that the various deductions in respect of tax concessions admissible
under the Income-tax Act do not result in reducing the taxable income of companies to the
extent that no tax or only negligible tax is paid by profit-making companies, it is proposed to
make a provision in the Income-tax Act to the effect that where in the case of companies the
aggregate amount of deductions admissible under certain specified provisions of the Income-
tax Act exceeds 70 per cent of the amount of total income computed before making such
deductions, the amount to be deducted under those provisions will be restricted to 70 per
cent of the total income as computed before making such deductions…”

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Purpose of MAT (contd…)
 Rationale of s. 115J - Surana Steel Pvt Ltd. v. CIT (104 Taxman 188)
 “Section 115J was introduced in the assessment year 1988-89 to take care of the
phenomenon of prosperous zero tax companies which had continued in spite of the
enactment of section 80VVA. There were companies which were paying no income-tax
though they had profits and were declaring dividends. A minimum corporate tax was sought
to be ensured on prosperous companies.”

 Proviso to s. 123(1)(a) of the Companies Act, 2013 –


 “Provided that in computing profits any amount representing unrealised gains, notional gains or
revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of
the asset or the liability at fair value shall be excluded, or”

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Purpose of MAT (contd…)
 1st Report of the MAT-Ind AS Committee (under the convenorship of M P Lohia)
dated March 18, 2016 :
 “2. The provisions of section 115JB of the Act provide for levy of MAT on the basis of "book
profit" i.e. the net profit disclosed in the profit and loss account prepared in accordance with
the provisions of the Companies Act. For determining the book profit, section 115JB of the
Act provides for certain adjustments mainly for items relating to income-tax, appropriation
of profit, adjustment for brought forward loss/unabsorbed depreciation, revaluation of
assets, distribution of dividend, etc. The adjustment for brought forward loss/unabsorbed
depreciation is provided on the basis of the provisions contained in section 205 of the
Companies Act, 1956 which provides computation machinery for determining the amount
available for distribution of dividend. The adjustments indicate that the provisions of section
115JB of the Act seek to compute the realised profit before tax which is available for
appropriation/distribution. Hence, there appears to be an implicit relation between the
distributable profits which is available for payment of dividend under the Companies Act
and the tax base for levying MAT under section 115JB of the Act.”

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One-time Settlement Agreement
 Co. A (facing financial difficulties) has a loan liability of Rs. 100 currently repayable
 Bank B agreed to convert the loan liability to 0.01% preference shares (face value of
Rs. 100) which will be redeemed at par after 10 years
 On the date of conversion, the fair value of preference shares amounts to Rs. 40
 Accordingly, Co. A to pass the following entry:
Entry
Loan Liability Dr. 100
To 0.01% Preference Shares 40
To Profit or Loss 60

 No dividend can be declared on Rs. 60 ;


 If MAT levied on such amount, it will be against the objective of helping companies
which are facing financial difficulty
Can Para 19 of Ind AS 1 be invoked?
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Accounting Policies and Changes
 Deviation from Ind AS is permitted in extremely rare circumstances – Para 19 of
Ind AS 1 – “Presentation of Financial Statements”
 “In the extremely rare circumstances in which management concludes that compliance with
a requirement in an Ind AS would be so misleading that it would conflict with the objective
of financial statements set out in the Framework, the entity shall depart from that
requirement in the manner set out in paragraph 20 if the relevant regulatory framework
requires, or otherwise does not prohibit, such a departure.”

 Objectives of Financial Statements – Framework for the Preparation and


Presentation of Financial Statements in accordance with Ind AS (“Framework”)
 To provide information about financial position, performance and cash flows
 To provide information that users may need to make economic decisions

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Demergers

 Resulting Company (Not under common control):


 Required to record the assets and liabilities at fair values
 Contrary to s. 2(19AA)
 Can Scheme provide for recording at Book Values? Auditors’ certificate?
 Way out?
• Two stage accounting treatment
• 1st stage: Record at Book Values
• 2nd stage: Bring it in line with Ind AS

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Debentures (Profit or Loss)
 Assume Co. A invested Rs. 150 in debentures (maturity = 5 years) of Co. B on April 1,
2015
 Under AS, Co. A had recorded Rs. 150 as long-term investments (as per AS 13)
 Under Ind AS 32 / 109, Co. A elected to measure the investment at fair value through
profit or loss
 The fair value of such investments is as under:
Dates Fair Value
April 1, 2017 120
March 31, 2018 110
 Co. A to pass the following entry on April 1, 2017 (transition date)
Retained Earnings 30
To Investment in Debentures (Rs. 150 – Rs. 120) 30

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Debentures (Profit or Loss) (contd…)
 On March 31, 2018, Co. A to pass the following entry:
Profit or Loss 10
To Investment in Debentures (Rs. 120 – Rs. 110) 10

 Under AS, if the amount of Rs. 40 were to be debited to the Statement of Profit or Loss
as provision for diminution in the value of asset, it would have to be added back as per
clause (i) of Explanation 1 to s. 115JB
 Would the above position change u/s. 115JB for Ind AS compliant companies or would
Rs. 40 be deducted from the book profits?
 Yes - The amount of Rs. 40 would be considered as transition amount and be deducted from
book profits over 5 years – Q. 1 r.w. Q. 6 of the CBDT Circular 24/2017 dated July 25, 2017

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2. Re-introduction of long term capital gains tax
Provisions prior to introduction of s. 112A

PROVISIONS FOR & UPTO A.Y. 2017-18

 Exemption of LTCG arising on transfer of Equity shares; unit of equity oriented fund, unit of business
trust on transfer happening on or after October 1, 2004, subject to payment of STT
 No exemption for MAT

PROVISIONS for A.Y. 2018-19

 Exemption from LTCG arising on sale of equity shares which were acquired on or after October
1, 2004 only if:
a) STT is paid on acquisition; or
b) The transaction is notified as exempt

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S. 112A – Applicability (from AY 2019-20)

Asset
• Chargeable under the transferred • Acquisition and
head capital gains transfer, in case of
• An equity share in a LTCA being an
company or equity share
• Unit of an equity
oriented fund or
• Unit of a business
trust STT has been
Income paid

Tax Computation = Long term capital gains would be taxed @ 10% in excess of Rs. 1 lakh

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Analysis
 Indexation benefit and benefit of exchange fluctuation as provided in the 1st and 2nd
proviso to s. 48 not to be applicable to LTCG as computed u/s. 112A (3rd proviso to s.
48)

 Benefit of grandfathering u/s. 55(2)(ac) - Applicable for shares acquired on or before


February 1, 2018

 CBDT vide notification dated April 24, 2018 - specifies the nature of acquisitions in
respect of which STT need not have been paid to avail the provision of S. 112A.

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Start

N
Was STT paid on transfer
Y
Acquisition in Y
Was STT Was
N delisting period
paid on acquisition N
acquisition < 1.10.2004 N

Was share Y Not frequently N


Y Y listed on date Permissi Permiss
traded?
of acquisition ble ible
Y
Mode B Mode
N Preferential N Acqn N (1 to 8) N N
B(9)
issue on
Y RSE Y
Permissible Mode A Y Run Chart
Y
Test For P.O.
Y
P.O. Result

112A N.A.
Section 112A applies
Apply S.112
COA- s. 55(2)(ac)
Mode A
Sr. Exceptions to Clause (a) – Acquisition through a preferential issue - Shares not frequently traded
1. Acquisition which has been approved by SC, HC, NCLT, SEBI or RBI
2. Acquisition by any non-resident in accordance with FDI guidelines issued by the Government of India
3. Acquisition by a Category I or Category II Alternate Investment Fund (AIF) or a Venture Capital Fund (VCF) or a Qualified
Institutional Buyer (QIB)
4. Acquisition through a preferential issue to which provisions of Chapter VII of the ICDR Regulations, 2009 do not apply –

• Conversion of loan or option attached to convertible debt instruments in terms of s. 81(3) and 81(4) of the Companies
Act, 1956 or s. 62(3) and 62(4) of the Companies Act, 2013;

• Scheme approved by a HC (u/s. 391 to 394 of the Companies Act, 1956) or NCLT (u/s. 230 to 234 of the Companies
Act, 2013)

• Rehabilitation scheme approved by Board of Industrial and Financial Reconstruction under the Sick Industrial
Companies (Special Provisions) Act, 1985 or NCLT under the Insolvency and Bankruptcy Code, 2016; and

• Acquisition by secured lenders pursuant to conversion of their debt into equity shares under the strategic debt
restructuring scheme in accordance with the guidelines specified by the RBI

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Mode B
Sr. Exceptions to Clause (b) – Acquisition not through a RSE
1. Acquisition through an issue of share by a company other than preferential issue of non-frequently traded shares
2. Acquisition by scheduled banks, reconstruction or securitisation companies or public financial institutions during their
ordinary course of business
3. Acquisition which has been approved by the SC, HC, NCLT, SEBI or RBI in this behalf
4. Acquisition under employees stock option scheme or employee stock purchase scheme framed under the SEBI
(Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999

5. Acquisition by any non-resident in accordance with FDI guidelines of the Government of India
6. Acquisition of shares of company under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
7. Acquisition from the Government
8. Acquisition by a Category I or II AIF or a VCF or a QIB
9. Acquisition by mode of transfer referred to in s. 47 (transactions not regarded as “transfers”) or s. 50B (slump sale) of
the Act if the acquisition by the previous owner was not an Improper Acquisition

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Determination of Cost of Acquisition u/s. 55(2)(ac)

 A long-term capital asset, referred in s. 112A, acquired before the 1st day of February,
2018 shall be:
Higher of : (i) Cost of Acquisition of the long term capital asset; or
(ii) Lower of : (i) - Fair market value of the long term capital asset or
(ii)- Full value of consideration received or accrued

Determination of Fair market value


Asset Transferred Determination
1) Listed on the RSE as on 31.1.18 Highest price quoted on that date
2) Not Listed on the RSE as on 31.1.18, but listed on date of transfer COA * CII of FY 17-18
CII of Year of acquisition or
3) Listed on date of transfer and which became the property of the assessee in
2001 whichever is later
consideration of share which is not listed on such exchange as on the 31st day of
January, 2018 by way of transaction not regarded as transfer u/s. 47

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Illustrations (1/3)
Particulars
Date of Transfer June 1, 2018
STT paid on acquisition No
Listed on date of transfer Yes
Date of acquisition April 2018
Mode of acquisition Gift

 As per clause (b)(ix) of the Notification, if the previous owner has acquired the shares through
qualifying acquisitions, the assessee is covered by the said notification
 Therefore, if the provisions of s. 112A were applicable to the previous owner, the provisions of s.
112A would apply to the donee
 COA - Cost to previous owner, FMV as on 31.1.18, Grandfathering allowable
 No indexation benefit

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Illustrations (2/3)

Particulars
Date of Transfer July 2018 in Offer for Sale in IPO
STT paid on acquisition No
Listed on date of transfer No, but STT payable u/s 97(13) of FA
2004
Date of acquisition April 1996
 Section 112A would apply. Therefore indexation not available.

 Computing COA- Since, the shares not listed on the date of transfer, grandfathering u/s 55(2)(ac) not
available (Expln (a)(iii)(A) and (B) apply only to shares listed on date of transfer.

 However, substitution of FMV as on 1.4.2001 available because 55(2)(ac) is “subject to” 55(2)(b)

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Illustrations (3/3)

 Co A has demerged its Real estate Undertaking to Co B, with Appointed Date being 1.4.2018,
 In consideration of the demerger, Co B has issued its shares to shareholders of Co. A.
 A shareholder transfers shares of both the companies, COA to be as per s.49(2C)

Particulars Demerged Company Resulting Company


Date of Transfer 1 January 2019 1 January 2019
Listed or unlisted Unlisted Listed in December 2018
Listed on date of transfer No Yes
Date of acquisition Prior to 1.4.2001 Record date –November 2018
112A would apply No Yes
Indexation Yes, since covered by section 112 No
Grandfathering available NA No, since 55(2)(ac) applies for acquisition of
securities referred to in 112A, prior to 1.2.2018
FMV as on 1.4.2001 – whether Yes. Bifurcation of COA as per s. 49(2C) Yes
available is done after substituting FMV as on
1.4.2001
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4. Section 50CA& Section 56(2) & Valuation
Rules?
Interplay between section 50CA and 56(2)(x)

Finance Act, 2017

Section 50CA Section 56(2)(x)


Provision to tax the difference between the FMV Provisions to tax the difference between the FMV and
and the consideration received for transfer of the consideration paid for transfer of unquoted shares
unquoted shares as capital gains in the hands of (also covers sum of money, immovable property, other
transferor property) as income from other sources in the hands of
transferee

Incidence of double taxation – Both in the hands of transferor as well as transferee –


subject to section 49(4)

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Interplay between section 50CA and 56(2)(x) (contd…)

Example
 Transferee/Buyer : A Ltd.
 Transferor/Seller : B Ltd.
 A Ltd. purchased 100 shares of a private company from B Ltd. for a price of INR 600 per share;
total consideration = INR 60,000
 B Ltd. had acquired such shares at INR 500 per share; gross amount paid = INR 50,000
 Say, the FMV of said shares on transfer date is INR 700

What would be the implications of provisions of section 50CA and 56(2)(x) under the
mentioned circumstances ?

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Interplay between section 50CA and 56(2)(x) (contd…)

 Prior to amendment
Impact on Transferor – B Ltd. Impact on Transferee – A Ltd.

Sale consideration 60,000 No impact


Less: Cost of acquisition (50,000)
Capital gains 10,000

 Post amendment
Impact of Sec. 50CA Impact of Sec. 56(2)(x)
Transferor – B Ltd. Transferee – A Ltd.

FMV 70,000 FMV of shares 70,000


Less: Cost of acquisition (50,000) Less: Actual consideration (60,000)
Capital gains 20,000 IFOS 10,000
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Interplay between section 50CA and 56(2)(x) (contd…)

 Impact u/s 49(4) :-

When A Ltd sells the shares at (say) Rs.800 (which is also its FMV) ;

FMV of shares (when sold) 80,000

Less: FMV(when purchased) (70,000)

Capital gains 10,000

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50CA presupposes consideration

 Applicability of the provisions in the absence of consideration


 In case no consideration is received or accruing, section is not applicable :-
• Transfer by a partner to the firm as capital consideration ;

 In case of a gift (no consideration at all) ;


• No capital gains, therefore section is not applicable

 Transfer should be in relation to transfer of a “capital asset” only

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Rights and Bonus issue and s. 56(2)(x)
 Section 56(2)(x) – Any person ‘receives’ any property without consideration or for
inadequate consideration ;
 Property includes shares and securities ;
 ‘Receives’ presupposes the existence of the shares at the time when the person receives
 Right issue and bonus shares are fresh allotments by the Company – Can such receipt of
shares be regarded as receipt of property without consideration or for inadequate
consideration?
 Sudhir K Menon (HUF) v. ACIT (162 TTJ 425)(Mum)
• Issue of bonus shares – merely capitalisation of profits of a company; no receipt of property
• Proportionate allotment in case of rights issue, no receipt of property
 DCIT v. Dr. Rajan Pal (180 TTJ 714) (BangT)

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Convertible Instruments and s. 56(2)(x)
 Receipt of equity shares is in ‘consideration’ of extinguishment of rights in bonds/preference
shares :-
 Hence, not without consideration ;
 Also not inadequate consideration – sacrifice = gain ;
 Ratio of CIT v. Bai Shrinibai K. Kooka (46 ITR 86) (SC) and CIT v. Groz-Beckert Saboo
(116 ITR 125) (SC)

 Taxing event arises when convertible instrument is issued. Upon conversion:


 Mere working out of pre-exiting rights of the investor or mere discharging of pre-existing
obligation by the issuer
 Ratio of CIT v Mohanbhai Pamabhai (165 ITR 393) and CIT v. R.M. Amin (106 ITR 368)
(SC)

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Other Issues
 What would be the position in case of buy-back of shares?
 M/s. Vora Financial Services P. Ltd v. ACIT (ITA No. 532/Mum/2018)

 What happens in case of rights renunciation?

 Receipt of shares on amalgamation of foreign company – by virtue of holding shares in


amalgamated company –
 Whether s. 56(2) applicable ?
 Whether capital gains payable ?

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Rules – Whether fair

 Empirical studies show that market value of equity shares of an investment company does not capture the full market
value of its investments in other companies. The value leakages are on account of distance of time and control of
ownership, which, thereafter results in an inevitable discount especially because of the economic concept of liquidity
preference which requires converting a future inflow to its present value by using a rate of discount. Also, erosion on
account of tax leakages normally get factored in such valuation. The rule is unrealistic and would result in notional
taxation in cases where the transaction has happened at fair value considering the above aspects.

 Valuation of equity shares of a company which carries on business as a going concern cannot be made based on present
market value of its immovable property. Market value of an immovable property may be considered only in case the
valuation is for the purpose of liquidation, or when the property is in surplus and is not actively used in business.

 For immovable property “the value adopted or assessed” will never exist in case of sale/transfer of shares of a company.
It will always be “the value assessable”. Indeed, value assessable as per ready reckoner/circle rate does not always reflect
the fair market value. There have to be enough safeguards like in s. 50C if Stamp Duty value is to be considered even for
share valuation.

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Issues on Rules

 Valuation in cases of cross holdings is not addressed in the rules ;

 As per the rules, equity shares of a foreign company would be “unquoted equity share” even if it is
listed on a foreign stock exchange.

 The rules come into force from 1.4.2018 – i.e. AY 18-19


 Rule Notified on 12 July 2017. For Transaction between 1 April 2017 and 12 July 2017- will Rules apply;

 The rules shall apply irrespective of the valuation methodology agreed upon in Shareholder’s
Agreement/ J.V. Agreement;

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Issues on Rules (contd…)

 The rules may apply irrespective of lock-in-period under such Shareholder’s Agreement/ J.V.
Agreement where internal transfer to Affiliates is permitted ;

 Leasehold rights in land whether to be considered for computing the value of shares for the purpose of
section 56(2)(x) / 50CA r.w. Rule 11UA

 Acquisition of shares in tranches – what would be the date of valuation


 As per Rule 11U of the Rules “valuation date" means the date on which the property or consideration, as the
case may be, is received by the assessee
Question : In case of receipt of staggered consideration on different dates- what would be the date of valuation

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YOGESH THAR
Applicability to transfer of Indian company shares
between foreign companies either by way of gift or sale
Section 56(2)(x)
Gifts shares of IC
FC 1 FC 2  Where any person receives in any previous year, from
any person
• Receipt of shares by FC 2/ FC 1
IC
Section 5
 Since change of name in IC’s Share Register - the
FC 1 receipt is in India
Gifts shares of IC  Falls within the scope of total income
WOS

Therefore receipt taxable in India u/s 56(2)(x)


FC 2
 Even in Case of WOS, FC1 is not an Indian Company
hence 56(2)(x) applicable
IC
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YOGESH THAR
Applicability to transfer of Indian company shares
between foreign companies either by way of gift or sale
Section 56(2)(x)
 Where any person receives in any previous year, from
FC 1 FC (3) any person
Gifts shares
• Receipt of shares by FC (3)
of FC 2
Section 5
 Since, the receipt is not in India, it is outside the scope
FC 2 of total income

Section 9(1)
 Income accruing or arising directly or indirectly
through the transfer of a capital asset situated in India
IC
Taxability u/s 56(2)(x) is triggered on “receipt” and not
on “transfer”

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YOGESH THAR
Applicability to S.8 Companies

Questions :
Co A X Ltd
Issue of 1000 shares
at Rs. 10 per share  What would be the addition under section
56(2)(x) in the hands of X Ltd.?
Co. A is registered under section 8 of the Companies Act, 2013
The Balance Sheet of Co. A as on the valuation date is as under:
 Would the position differ if Co. A is
Liabilities Assets registered under section 12A/AA of the Act?
Share capital 1,00,000 Movable 20,00,000
(10000 shares of Fixed Assets  Would the position differ if X Ltd. was
Rs. 10 each) registered under section 8 of the Companies
Surplus 24,00,000 Current Assets 4,00,000 Act, 2013 and not Co. A?
Cash/ Bank 1,00,000
Balance
25,00,000 25,00,000

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YOGESH THAR
Applicability of Rule- Pre or Post Issue

 Balance Sheet of P Ltd. Pre issue


Questions :
Liabilities Assets
 Would Rule 11UA apply even in case of issue of
Share capital 50,000 Plant & 30,00,000
shares?
(5000 shares of Machinery
Rs. 10 each)
 If yes, what would be the Rule 11UA value of the
Loans 25,00,000 CAs 20,00,000
shares issued to Mr. A? (Pre-issue: 600-10=590
Surplus 29,50,000 Bank Balance 5,00,000 for 5000 shares = 29,50,000
55,00,000 55,00,000
 As against this, what would be the holding of Mr.
 Net Worth of the company: A – L = Rs. 30,00,000 A in P Ltd. post acquisition of the shares?

 Value as per Rule 11UA: A– L = Rs. 600/share  Can addition under section 56(2)(x) exceed the
No. of shares real benefit?
 Mr. A has been allotted 5000 shares of P Ltd. at face value on
preferential basis

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YOGESH THAR
Applicability of Rule- Pre or Post Issue (contd…)

Liabilities Assets
Share capital 100,000 Plant & Machinery 30,00,000
(10,000 shares of Rs. 10
each)
Loans 25,00,000 CAs 20,00,000
Surplus 29,50,000 Bank Balance 5,50,000
55,50,000 55,50,000

Shareholding of Mr. A in P Ltd - 5000 shares

% shareholding of Mr. A in P Ltd. (5000/10000*100) 50%


Net worth of P Ltd. post issue of A-L : 55,50,000 – 25,00,000 Rs. 30,50,000
shares
Value of shareholding of Mr. A based 50% of 30,50,000 Rs. 15,25,000
on post – issue balance sheet
Actual Benefit to Mr. A 15,25,000 – 50,000 Rs. 14,75,000
Addition u/s. 56(2)(x) based on pre- 30,00,000 – 50,000 Rs. 29,50,000
issue balance sheet

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YOGESH THAR
Multi layered shareholdings

 Would Mr. Z be required to compute FMV of C Ltd.


A Ltd while computing Rule 11UA value of A Ltd.?

 If yes, as on which date?


B Ltd
 Similarly, would he require to compute the fair
market value of B’s interest in P-LLP?

C Ltd P-LLP  Would the position change if P-LLP held immovable


properties?

Mr. Z is to purchase shares of A Ltd.  In case, A Ltd. holds leasehold rights in a plot of
land, would its fair market value be considered under
Rule 11UA?
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YOGESH THAR
5. TAXABILITY OF ESOPS
Taxability of ESOPs

Grant of Options

 No income tax implication in the hands of the employee

Vesting of Options

 No income tax implication in the hands of the employee

Exercise of Options

 Difference between fair market value and the exercise price - Taxed as perquisites
 Determine FMV as per the Income-tax Rules, 1962
 Tax deduction at source u/s. 192 of the Income-tax Act, 1961

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YOGESH THAR
Taxability of ESOPs (contd…)

Sale of shares

 Capital gains tax liability - Difference between consideration received and cost of acquisition
 Cost of acquisition = FMV taxed as perquisite
 Determine period of holding from date of allotment / transfer

Recent development in taxability of Stock


Appreciation Rights (SARS)

 ACIT v. Bharat V. Patel (Civil Appeal No. 4380 of 2018) (SC)


 Amount received on redemption of SARs prior to amendment in s. 17(2) is not taxable as perquisite in
the absence of an express provision of retrospective effect
 Further, the said amount is not taxable u/s. 28(iv) since s. 28 only deals with any business or
profession related transactions

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YOGESH THAR
Issues under DTAA

 Timing mismatch in taxing the ESOP benefit

 Distinguishing employment income from Capital Gains

 Difficulty in linking ESOP benefit to employment

 Difficulty due to exercise of employment in multiple states

 Multiple residence taxation

 Compliance issue

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YOGESH THAR
Deductibility of ESOP expenses

 Accounting treatment and SEBI guidelines permit amortisation

 Allowability u/s. 37: Law getting settled in favour of allowability of the amount debited to
P&L…
 Allow –
• CIT v. PVP Ventures Ltd. [TC (A) No. 1023 of 2005 (Mad HC)]
• CIT v. Lemon Tree Hotels Ltd. (ITA No. 107/2015) (Del HC)
• CIT v. People Interactive India P. Ltd. (ITA Nos. 6990, 6986, 4979/M/2015)

 Quantum of deduction –
• Biocon Ltd. v. DCIT (ITA Nos 368/369/370/371/1206/Bang/2010)

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YOGESH THAR
Deductibility of ESOP expenses (contd…)

 No cash payout by Indian company to foreign parent of discount amount incurred by


foreign parent – Whether deductible by Indian company?

 Indian company issues shares to employees of foreign subsidiary at discount – Whether


deductible by Indian company?

 Transfer Pricing implications?

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YOGESH THAR
Ind AS – MAT implications

 Hold Co. grants 200 share options to each of 100 employees of Sub Co., conditional upon the
completion of 2 years’ service with Sub Co
 The fair value of the share options on grant date is Rs. 30 each
 At grant date, Sub Co. estimates that 80% of the employees will complete 2-year service period
 At the end of the vesting period, 81 employees complete 2 years’ of service
 Hold Co. does not require Sub Co. to pay for the shares needed to settle the grant of share
options
 Sub Co. to pass the following entries as per Ind AS 102:
Year 1
Remuneration expense 2,40,000
To Other Equity (Deemed Capital Contribution) 2,40,000
(200 options x 100 employees x Rs. 30 x 0.8/2 years)

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YOGESH THAR
Ind AS – MAT implications (contd…)

 Hold Co. to pass the following entries as per Ind AS 102:


Year 1
Investment in Sub Co. 2,40,000
To ESOP O/s Account 2,40,000
(200 options x 100 employees x Rs. 30 x 0.8/2 years)

 Sub Co.
 Amount debited to profit or loss as remuneration expenses – Allowable under MAT
 Amount credited to Other Equity – Taxable under MAT if suggestion of Ind AS Committee Report is
accepted - Therefore, net impact on book profits will be NIL
 Hold Co.
 No amount is debited / credited to profit or loss. Therefore, no question of MAT
 However, amount credited to ESOP O/s. Account will form part of Other Equity – Will credit be
taxable under MAT if suggestion of Ind AS Committee Report is accepted ?
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YOGESH THAR
6. GAAR applicability to transactions in securities - in
particular for FPIs?
Circular no.7 of 2017 dated 27/01/2017

 Central Board of Direct Taxes (“CBDT”) has issued the said circular providing clarification on
implementation of GAAR

“Question no. 4: Will GAAR apply where the jurisdiction of FPI is based on non-tax
commercial consideration, and such foreign portfolio investor
(FPI) has issued P-notes referencing Indian securities? Will GAAR
apply to deny treaty benefits to a Special Purpose Vehicle (SPV) on
the ground that it is located in a tax friendly jurisdiction, or on the
ground that it does not have its own premises or employees?

Answer: GAAR shall not be invoked merely on the ground that the entity is
located in a tax efficient jurisdiction. If the jurisdiction of the FPI
is finalised based on non-tax commercial considerations and the
main purpose of the arrangement is not to obtain tax benefit,
GAAR will not apply.

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YOGESH THAR
Draft guidelines for GAAR implementation under Direct Tax
Code Bill, 2010 (“DTC”)
 A foreign investor has invested in India through a holding company situated in a low tax
jurisdiction “X”
 The holding company is doing business in the country of incorporation, i.e. “X‟, has a Board
of Directors that meets in that country and carries out business with adequate manpower,
capital and infrastructure of its own and therefore, has substantial commercial substance in the
said country “X”
 Would GAAR be invocable or would the arrangement be permissible ?

In view of the factual substantive commercial substance of the arrangement, Revenue would
not invoke the GAAR provisions.

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YOGESH THAR
Under the Act

 As per section 97 of the Act :

An arrangement shall be deemed to lack commercial substance, if—


…….
a transaction which is conducted through one or more persons and disguises the value,
location, source, ownership or control of funds which is the subject matter of such
transaction

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YOGESH THAR
Case Study
Mechanics :
 It is proposed to sell the shares of “C Ltd” to another
company “D Ltd”;
A Ltd.  In case the shares of C Ltd are directly sold to D Ltd, B Ltd
Country A
would be liable to tax in India.
Plausible option :
100% India  B Ltd. is liquidated and A Ltd being the shareholder of B Ltd
would be liable to tax u/s 46(2) of the Act ; but A Ltd. can
B Ltd. avail the treaty benefit (assuming grandfathering) and such
liquidation proceeds would be taxable in country of residence
49% – Country A;

C Ltd.  Subsequently, A Ltd. sells shares of C Ltd. to D Ltd.

 There would be negligible capital gains on such transfer in


Transfer of shares not chargeable to tax in
India, since COA of shares in C Ltd. would be the FMV on
Country A
the date of liquidation of B Ltd.
Can GAAR provisions be invoked
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YOGESH THAR
Example-10- Final Report on GAAR in the Act

FACTS :
A Ltd  The India-F1 tax treaty provides for non-taxation of
Y Ltd 100% capital gains in the source country and country F1
49% charges no capital gains tax in its domestic law.
Country- C1
Country- FI- LTJ  A Ltd is also designated as “ permitted transferee”
India of Y Ltd. “ Permitted transferee” means that though
Z Ltd X Ltd Debt
51% shares are held by A Ltd, all rights of voting,
management, right to sell etc., are vested in Y Ltd.
 Y Ltd is a company incorporated in country C1 and is a  As per the joint venture agreement, 49% of X Ltd’s
non-resident in India. equity is allotted to A Ltd and 51% is allotted to Z
 Z Ltd is a company resident in India. Ltd.
 A Ltd. is a company incorporated in country F1 and it is a
100% subsidiary of Y Ltd.  Thereafter, the shares of X Ltd held by A Ltd are
 A Ltd and Z Ltd form a joint venture company X Ltd in sold to C Ltd., a company connected to Z Ltd.
India after the date of commencement of GAAR group.
provisions. There is no other activity in A Ltd;
 As per the tax treaty with country F1, capital gain
Can GAAR provisions be invoked arising to A Ltd are not taxable in India.
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YOGESH THAR
Analysis

 The arrangement of routing investment through country F1 results into a tax benefit. Since there is no
business purpose in incorporating company A Ltd. in country F1 which is a LTJ, it can be said that the
main purpose of the arrangement is to obtain tax benefit. The alternate course available in this case is
direct investment in X Ltd. joint venture by Y Ltd. The tax benefit would be the difference in tax
liabilities between the two alternate courses.
 The next question is, does the arrangement have any tainted element? It is evident that there is no
commercial substance in incorporating A Ltd. as it does not have any effect on the business risk of Y
Ltd. or cash flow of Y Ltd. As the twin condition of main purpose being tax benefit and existence of a
tainted element are satisfied, GAAR may be invoked.
 Additionally, as all rights of shareholders of X Ltd are being exercised by Y Ltd instead of A Ltd. it
again shows that A Ltd. lacks commercial substance. Hence, GAAR may be invoked.

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YOGESH THAR
7. Penny stocks
Taxability u/s.115BBE

 Total income of an assessee :


 includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section
69D and reflected in the return of income furnished under section 139; or
 determined by the Assessing Officer includes any income referred to in section 68, section 69, section
69A, section 69B, section 69C or section 69D, if such income is not covered under clause (a)

Tax Computation = on the income computed above @ 60%


 No deduction in respect of any expenditure or allowance or set off of any loss allowed in computing
the income u/s 115BBE
 S.271AAC provides for a penalty of 10% of the tax payable under section 115BBE, in case an addition
has been made by the AO. No penalty would be leviable if assessee suomotu makes an addition in the
return of income;
Thus effective tax Computation = tax @ 60%+ penalty @10%= effective tax rate =66%

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YOGESH THAR
Safeguards against transactions being treated as
fictitious

The shares are traded on the Stock Exchange

The payments and receipts are routed through the bank

There is no evidence to indicate it is a closely held company

The trading on the Stock Exchange was not manipulated

Lack of adverse material produced by the Department

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YOGESH THAR
Documents required to prove genuineness

Contract notes for sale and purchase

Bank statements of broker

Demat account showing transfer in and out

Abstract of transactions furnished by stock


exchange

Audited Balance sheet of previous years

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YOGESH THAR
Judicial Analysis
 In favour of the assessee:
 Pr CIT vs. Prem Pal Gandhi (P&H High Court)(ITA-95-2017)
 Shyam R Pawar v CIT (229 Taxman 256 (Bom HC)
 CIT v Jamna Dev Agarwal (328 ITR 656) (Bom HC)
 CIT v Vivek Mehta (204 Taxmann 177) (P&H HC)
 CIT v Mahesh Chandra G. Vakil (220 Taxmann 166) (Guj HC)
 Smt. Anjli Pandit v ACIT (188 TTJ 645) (Mumbai - Trib.)
 ITO v Arvind Kumar Jain HUF (ITA No. 4862/Mum/2014)

 In favour of the revenue:


 Sanjay Bimalchand Jain v PCIT (89 taxmann.com 196) (Bom HC)
 ITO v Shamim M Bharwani (170 TTJ 238)(MumT)

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YOGESH THAR
8. Transfer Pricing
Transfer Pricing

 Inbound Investments
 Whether subscription to shares of Indian Subsidiary by Foreign Co. considered as
‘international transaction’
 Vodafone India Services (P.) Ltd v. UOI (368 ITR 1) (BOM)
• TP provisions only apply if there is chargeable income resulting from the transaction
• Capital investments, which do not create chargeable income, cannot therefore be brought within
the scope of transfer pricing provisions

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YOGESH THAR
Transfer Pricing (contd…)

 Outbound Investments
 Whether subscription to shares of Foreign Subsidiary by Indian Holding Company
considered as ‘international transaction’
 M/s PMP Auto Components v DCIT (ITA 7724/Mum/2014)
• Investments in share capital outside India were in the nature of capital investments, and such
transactions are not in the nature of "international transactions" within the meaning of s. 92B

 Whether Rule 11UA value is a proper benchmark for transfer pricing ?


 FEMA requires internationally accepted valuation methodology ;

 Whether transfer pricing provisions would apply for buy-back taxable u/s 115-QA

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YOGESH THAR
Thank You