The curious case of CBDT's circular withdrawal!

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CBDT’s recent move to withdraw its December 31st circular has fermented some frenzy amongst stakeholders. The December 31st Circular issued by CBDT highlighted that Sec. 56(2)(viia) was inserted as an anti-abuse provision to prevent the practice of transferring shares of a closely held company for no or inadequate consideration and that it was never the intention of legislature to apply these provisions to ‘fresh issue of shares’. Astoundingly, had the circular not been withdrawn, every situation of fresh issue of shares to closely held companies would have been outside the tax net and any undervaluation in such shares would not have been brought to tax in the hands of the closely held companies. It is also hard to ignore the glaring fact that the withdrawal comes immediately after the Congress party claimed that the CBDT circular ‘vindicated’ their position in the National Herald case, thereby adding to the pungency of a political crossfire. However, citing 'subjudice' matters for withdrawing the aforesaid circular, CBDT has assured issuance of a comprehensive circular after afresh examination.

Can Revenue Department revisit the scope and intent of the anti-abusive provisions contained in Section 56(2) (viia) or 56(2)(viib) of the Income Tax Act 1961? Does the immediate withdrawal augur well especially considering the reasons cited for withdrawal? While the anti-abuse provisions should be invoked sparingly, will this ‘step-backward’ taken by CBDT result in misusing the provisions by taxmen by invoking the provisions in virtually all cases of undervaluation? Will this withdrawal adversely affect the investment climate?

K.R. Sekar
Partner, Deloitte Haskins and Sells LLP

A CBDT Circular on 31 December 2018 (also the last day available to tax authorities for completing certain tax assessments) clarified that shareholders subscribing to fresh shares of a specified company would not be covered within the rigour of section 56(2)(viia) of the Income-tax Act, 1961 (Act). This should have otherwise brought significant relief to a certain section of taxpayers had it not been for a subsequent CBDT Circular on 04 January 2019 which withdrew the initial Circular.

The quandary arises where shares are received as a part of fund raising exercises – fresh subscription of shares, rights issue or even bonus shares. These transactions are often at valuations which cannot be compared to the FMV prescribed under the Act.  Tax tribunal in certain cases have helped the case of taxpayers. For instance, decisions in the case of Vora Financial Services P. Ltd, Sudhir Menon (HUF) and Subodh Menon has clarified the applicability of section 56(2)(viia) of the Act.

The arguments that are typically taken by the taxpayer is well reflected in the CBDT Circular dated 31 December 2018. It is argued that the Memorandum explaining the Finance Act, 2010 had clarified that the intention of the provisions were to prevent the...

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Mukesh Butani
Founder, BMR Legal

The Finance Act 2010 inserted an anti-abuse provision (section 56(2)(viia) of the Act) dealing with a situation where shares of an unlisted company are “received” for no consideration or inadequate consideration. The Memorandum to Finance Act 2010 specifically targeted the anti-abuse provision  where shares are “transferred” for no consideration / inadequate consideration. The CBDT Circular on 31st December 2018 merely clarified that situation for fresh issuance including right, bonus, preference shares are outside the ambit of the said sub-section (viia) of the Act and specifically highlighted with the words “the intention was never to apply these provision to fresh issuance”. The 31stDecember Circular was withdrawn after 4 days of issuing the circular citing the reason that the issue is sub-judice before judicial Forum.

Coincidentally the Mumbai Tribunal was in the case of Vora Financial Services (P.) Ltd ([2018] [TS-7463-ITAT-2018(MUMBAI)-O] following the decision of Sudhir Menon HUF v. Asstt. CIT [2014] [TS-146-ITAT-2014(MUM)-O], analysed the question of taxability of bonus shares received by a shareholder. Also, the Bangalore bench of ITAT in the case of [TS-299-ITAT-2016(Bang)]followed Mumbai ITAT decision. 

Next,...

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Hitesh D. Gajaria
Partner and Head of Tax, KPMG India

Section 119 of the Income-tax Act, 1961 (IT Act) permits CBDT to issue Circulars inter alia to clarify ambiguous provisions of the IT Act.  However, such circulars must not be prejudicial to tax payers and must have general applicability instead of being case specific.  There have been several such instances in the past where CBDT has issued circulars to clarify its position, for e.g. CBDT’s Circulars, clarifying the characterization of gains on sale of listed and unlisted securities.  

Accordingly, seen in that light, Circular no 10/2018 issued by CBDT on 31 December 2018 clarifying that provisions of Section 56(2)(viia) shall not be applicable to cases of receipt of shares as a result of fresh allotment of shares appeared to be validly issued.  This is on the basis that the Circular was not prejudicial to the tax payers and was not case specific. 

As stated in the Circular, CBDT aimed at aligning the provisions of Section 56(2)(viia) with the stated objective of its introduction in the IT Act.  Accordingly, it does not appear that CBDT was trying to revisit the ambit of the anti-abuse provisions of Section 56(2)(viia). 

Further, where any Circular / Clarification is issued...

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Girish Vanvari
Founder, Transaction Square

What seemed to bring a refreshing clarity on a contentious issue by the CBDT on the New Year’s Eve turned out to be dampener soon enough. The CBDT vide its circular dated 31st December, 2018 initially clarified that provision of section 56(2)(viia) of the Income Tax Act, 1961 (‘the Act’) (which seeks to tax the transfer of shares of closely held companies if executed at less than Fair Market Value) shall not apply to fresh issue of shares by the Company since the intent of the legislature was to bring within its ambit only transfer of shares at a price less than fair value. 

On plain reading of the word ‘receives’ used in section 56(2)(viia) of the Act, it seemed that all the transactions including a primary issuance of shares shall be covered within the ambit  of the aforesaid anti-abuse provision. However, on reference to the Memorandum to Finance Act 2010, the year in which the provision was introduced, one would find the following words:

“…… In order to prevent the practice of transferring unlisted shares at prices much below the fair market value,……”

The discrepancy in the letter of law vis-à-vis the intent stated...

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Uday Ved
Partner, KNAV & Co

Circular No. 10/2018 dated December 31, 2018 was issued by Central Board of Direct Taxes (‘CBDT’) to address tax issues created by the provisions of section 56(2)(viia) (as it existed till March 31, 2017) of the Income Tax Act, 1961 (‘the Act’) and provide relief to taxpayers and exclude genuine transactions from being trapped within the claws of the anti-abuse provisions. 

Memorandum to Finance Bill, 2010 specified that Section 56(2)(viia) was introduced to curb practice of ‘transferring’ unlisted shares at prices much less than its fair market value. 

The Circular No. 10/2018 noted that the ‘receipt’ used in Section 56(2)(viia) being of wider import and might lead to taxation of income in cases where the shares are received by a firm or a closely held company as result of ‘fresh issuance’ of shares including by way of issue of bonus shares, right shares and preference shares or transactions of similar nature by the specified company. 

The said circular stood withdrawn vide Circular No. 2/2019 dated January 4, 2019 issued by CBDT. 

The reasons stated for such withdrawal of the circular issued previously were as under:

The interpretation of term ‘receives’ used in section...

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K R Girish
K R Girish & Associates

Section 56(2)(viia) of the Income-tax Act, 1961 (“Act”), inserted vide Finance Act, 2010, as an anti-abuse provision, provides to tax the income of a firm or a company in which public are not substantially interested (“specified company”) which receives shares of a specified company from a person, for no, or, inadequate consideration.

In this regard, on December 31, 2018 the Central Board of Direct Taxes (“CBDT”) issued a Circular No.10/2018, clarifying the legislative intent of the said anti-abuse provision.  The said Circular clarified that the provisions of Section 56(2)(viia) of the Act will get triggered only in a case where the, shares  are “transferred”, and not, when they are “issued”, for Nil or inadequate consideration. Further the term ‘issued’ includes fresh issue, bonus issue and rights issue of both equity and preference shares. Surprisingly, the CBDT withdrew the said Circular on January 04, 2019 vide Circular No. 02/2019 citing the reason that the word “receives” used in Section 56(2)(viia) of the Act is pending before judicial forums, and hence the matter is required to be examined afresh so that a comprehensive circular on the matter can be issued. 

Considering the above as the reason, the withdrawal...

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