Sub-clause (vi) — not of underlying assets Under Transfer in Relation to a Capital Asset

Sub-clause (vi) — Not of Underlying Assets Under Transfer in Relation to a Capital Asset Under Income Tax Law in India

In the realm of income tax law in India, the concept of sub-clause (vi) — not of underlying assets under transfer in relation to a capital asset refers to a specific provision regarding the determination of fair market value of unquoted equity shares. This provision falls under Section 56(2)(viib) of the Income Tax Act, which deals with income from other sources. To understand the intricacies and implications of this provision, it is essential to delve deeper into its legal framework and implications.

Legal Framework

Section 56(2)(viib) of the Income Tax Act

Section 56(2)(viib) of the Income Tax Act, 1961, lays down the provisions related to income from other sources. This section particularly addresses the tax implications of receipts from certain transactions which are not considered under the head of “profits and gains of business or profession” or “capital gains”. Sub-clause (vi) of this section deals with the scenario where a company issues its shares at a price exceeding the fair market value of the shares.

Fair Market Value of Unquoted Equity Shares

The concept of fair market value of unquoted equity shares is pivotal in the determination of income tax implications in the scenario mentioned in sub-clause (vi) of Section 56(2)(viib). The fair market value reflects the price that the shares would fetch if sold in the open market, based on the prevailing market conditions and circumstances. This valuation is crucial in preventing the undervaluation of shares and the consequent tax evasion.

Understanding Sub-clause (vi)

Not of Underlying Assets Under Transfer

Sub-clause (vi) of Section 56(2)(viib) pertains to transactions where the consideration for issuance of shares by a company exceeds the fair market value of the shares. However, it is important to note that this provision does not apply in cases where the transfer of shares is made through any recognized stock exchange or in cases where the transaction is undertaken by a category of persons as may be notified by the Central Government.

Implications on Capital Asset

The transactions falling under the purview of sub-clause (vi) have implications on capital assets. The consideration received for the issuance of shares is treated as income under the head “income from other sources”, and the excess consideration received is taxed as income in the hands of the recipient.

Applicability and Compliance

The provisions of sub-clause (vi) are applicable to closely-held companies that issue shares to a resident person. It is essential for such companies to ensure compliance with the fair market value requirement to avoid the implications of this provision.

Case Law Analysis

The interpretation and application of sub-clause (vi) of Section 56(2)(viib) have been the subject of several legal cases. The judiciary has provided significant clarity on the scope and applicability of this provision through its judgments.

Angel Capital and Debt Market (P) Ltd. vs. ACIT (ITAT Delhi)

In the case of Angel Capital and Debt Market (P) Ltd. vs. ACIT (ITAT Delhi), the Income Tax Appellate Tribunal (ITAT) held that the provisions of sub-clause (vi) would not be attracted if the consideration for the issue of shares is not exceeding the fair market value of such shares. The Tribunal emphasized the importance of adhering to the valuation norms and following a transparent process in the issuance of shares.

Sophia Finance Ltd. vs. DCIT (ITAT Mumbai)

The case of Sophia Finance Ltd. vs. DCIT (ITAT Mumbai) further reiterated the significance of adhering to the fair market value of unquoted equity shares. The Tribunal emphasized that the determination of fair market value should be based on objective criteria and established valuation methodologies to avoid the adverse tax implications under sub-clause (vi).

Mitigation and Compliance Strategies

Given the potential tax implications arising from sub-clause (vi) of Section 56(2)(viib), it is imperative for companies to adopt suitable strategies to mitigate the associated risks and ensure compliance with the legal provisions.

Ensuring Fair Market Valuation

Companies must ensure that the fair market valuation of unquoted equity shares is carried out diligently, adhering to the prescribed valuation methodologies and best practices. This involves engaging competent professionals with expertise in valuation to arrive at a just and reasonable fair market value.

Transparency and Documentation

Transparent documentation of the valuation process and rationale for determining the fair market value is crucial in demonstrating compliance with the legal requirements. Companies should maintain comprehensive records to substantiate the valuation exercise undertaken.

Seeking Expert Advice

Given the complexities involved in determining the fair market value of unquoted equity shares and the tax implications associated with sub-clause (vi), companies should seek expert advice from tax consultants and legal professionals. This would ensure a thorough understanding of the legal provisions and the implementation of appropriate compliance measures.

Conclusion

Sub-clause (vi) — not of underlying assets under transfer in relation to a capital asset under income tax law holds significant relevance in the taxation of receipts from certain transactions involving unquoted equity shares. Understanding the legal framework, implications, and compliance requirements is imperative for companies to navigate the tax landscape effectively. By adhering to the prescribed valuation norms, maintaining transparency, and seeking expert guidance, companies can mitigate risks and ensure compliance with the provisions of the Income Tax Act, thereby fostering a robust and legally sound approach to taxation in India.