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Proportionate allotment of additional shares does not result into income under
Section 56(2)(vii)(c) of the Act
19 March 2014
B
Background
Recently, the Mumbai Bench of the Income-tax Appellate
Tribunal (the Tribunal) in the case of Sudhir Menon HUF1
(the taxpayer) held that since shares were allotted on prorata basis to the shareholders based on their existing
holdings, additional property was not received by them. It
was only an apportionment of the value of their existing
holding over a larger number of shares. Accordingly,
Section 56(2)(vii)(c) of the Income-tax Act, 1961 (the Act)
does not get attracted in the present case.
With respect to right shares if they are allotted to a person
not against his existing shareholding or if they are allotted
to existing shareholders but disproportionately, there is a
scope for value or property being passed on to him and
would attract Section 56(2)(vii)(c) of the Act.
Further in case of bonus shares, there is neither any
increase nor decrease in the wealth of the shareholder
and therefore, the provisions of Section 56(2)(vii)(c)
would not apply to bonus shares.
________________
1
Sudhir Menon HUF v. ACIT (SA No. 192/Mum/2013)
The Tribunal analysed the tax implication under
two categories i.e. allotment on a proportionate
basis and on a disproportionate basis. The
Tribunal held that as regards proportionate
allotment there is no taxability under Section
56(2)(vii)(c) of the Act. However, in case of
disproportionate issue of additional shares, these
provisions may get attracted.
Facts of the case
The taxpayer, held 15,000 shares as on the
beginning of the relevant previous year, in Dorf
Ketal Chemicals Pvt. Ltd. (DKCPL), representing
4.98 percent of the entire share capital being
3,01,316 shares. The entire (or almost the whole)
capital in DKCPL was held by the family members
of the taxpayer’s karta’s family.
The taxpayer was offered 313,624 additional
shares (which works to about 21 shares for each
share held) at the face value rate of INR100 each,
on a proportionate basis. The taxpayer subscribed
to and was accordingly allotted 194,000 of those
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
The valuation date under Rule 11U(j) is the date
of the receipt of the property and the shares are
received on their allotment. Subsequently, the
share certificates are received which evidences
its title thereto.

Section 56(2)(vii)(c) seeks to substitute the FMV
as the normative basis for transactions involving
the receipt of property by a person, being an
individual or HUF. Exceptions for transactions are
provided and to that extent the provision is wellfounded and adequately excepted.

Section 56(2)(vii)(c) gets attracted whenever an
individual or Hindu undivided family (HUF) receives
without consideration a specified property, the FMV of
which is in excess of INR50,000, or in case of
consideration where the consideration is less than
FMV by an amount exceeding the INR50,000.
Section 56(2)(vii)(c) was further strengthened
and broadened, with Finance Act, 2010 wherein
the same was explained as an anti-abuse
measure. In the case of Khoday Distilleries Ltd.,
the Supreme Court held that this provision
together with the Wealth Tax Act, 1957 and the
Act forms an integrated code. While the Gift Tax
Act had sought to bring to tax the shortfall in
consideration in the hands of the donor, the
present provision/s seek to bring the same to tax
as income in the hands of the recipient of the
relevant assets.

Section 56(2)(vii) includes the ‘shares and securities’
as the word property occurring in section defined to
mean capital assets. However, the shareholders get
the right to acquire the additional shares on the
passing of the board resolution. This supported the
taxpayer’s contention that the provision being never
intended to cover a transaction of this nature i.e.
where the shares are offered to the existing
shareholders – though below market value, on rights
basis.
In certain situations, through the medium of
additional shares the controlling interest in a
company or interest in property – movable or
immovable, is passed on to another at
considerations far below the going rate of the
relevant or the underlying assets/interest. Only a
pro-rata allotment or, where not so, one that is
adequately priced, would effectively ensure an
exchange of the assets or interest therein at par
values.

In order to demonstrate the wholesomeness of
the provision, the matter of bonus share is dwelt
upon. Issue of bonus shares is capitalization of
its profit by the issuing-company and there is
neither any increase nor decrease in the wealth
of the shareholder (or of the issuing company)
and shareholder’s percentage holding therein
remains constant4. The same has the effect of
reducing the value per share, increasing its
mobility and, thus, liquidity. Accordingly, the
provision would not apply to issue of bonus
shares.
shares. Further, the other shareholders were allotted
similar shares and also those shares which were not
subscribed by the taxpayer i.e. 119,624 shares (313624 –
194000).
The book value of the shares of DKCPL as at the year-end
was INR 1,538 per share and the same adopted as a
measure of their fair market value (FMV) under the
applicable rules2. In terms of Section 56(2)(vii)(c) of the Act
read with the relevant rules, the Assessing Officer (AO)
treated the difference of INR 1,438 per share as
inadequate consideration toward the acquisition of
additional shares and brought the same to tax.
The issue before the Tribunal was the validity in law, of the
assessment of income being the difference between the
value of the shares allotted to the taxpayer and the
consideration paid by it in respect thereof.
Tribunal’s ruling



Relying on the various decisions3 it was held that the
shareholders get the right to acquire the additional
shares on the passing of the board resolution but the
receipt of the property is only on their allotment, on
which date the shares, a specifies property, comes in
existence.

‘Right share’ is appropriation out of the previously unappropriated capital of a company of a certain number
of shares to a particular person. Till such allotment, the
shares do not exist as such, and in a sense come into
existence on their allotment.
________________
____________________
2
Rule 11U and Rule 11UA of the Income-tax Rules, 1962 (Rules)
Shree Gopal and Company v. Calcutta Stock Exchange Ltd. [1963] 32 Comp. Cas.
862 (SC), Khoday Distilleries Ltd. v. CIT [2008] 307 ITR 312 (SC)
3
4
CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC), Khoday
Distilleries Ltd. v. CIT [2008] 307 ITR 312 (SC)
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
In the present case issue of additional shares in fact
reduced the taxpayers holding to 3.17 per cent from
4.98 per cent. Therefore, the premise on which this
provision was not applicable to issue of bonus shares,
would to the extent pari-materia, apply in equal
measure to the issue of additional shares, i.e. where
and to the extent it is proportional to the existing
share-holding.

Section 81 of the Companies Act, 1956 is not
applicable to a private company hence the company is
neither obliged to issue shares to the existing
shareholders nor issue on a proportionate basis. Thus,
though the issue has elements of a right issue since
the offer is made to the existing shareholders on the
basis of their shareholding on proportional basis
however, the same cannot be termed as a ‘rights
issue’ since the company was appropriating the right
which could be offered it to another.

To the extent the value of the property in the additional
shares is derived from that of the existing
shareholding, on the basis of which the same are
allotted, no additional property can be said to have
been received by the shareholder. For e.g. shares in
the ratio 1:1 are offered for subscription at the face
value of INR100 as against the current book value of
INR1500. The moment a right share is allotted, the
book value shall fall to INR800 per share. It is easy to
see that the new share partakes a part of the value of
the existing share, which is only on the basis of the
underlying assets on the company’s books. The
excess or 1,400 gets apportioned over two shares as
against one earlier, which is already the shareholders’
property. In support of this the Tribunal placed reliance
on various decisions5.

The shares are allotted pro-rata to the shareholders
based on their existing holdings and therefore, there is
no scope for any property being received by them on
the said allotment of shares; there being only an
apportionment of the value of their existing holding
over a larger number of shares. Accordingly, Section
56(2)(vii)(c) of the Act does not get attracted in the
present case though, it is per se applicable to the
transaction, i.e., of this genre.

A higher than proportionate or a non-uniform allotment
would attract the rigor of the provision on the same
premise. A disproportionate allotment could also result
on a proportionate offer, where on a selective basis
some shareholders abstain from exercising their rights
(wholly or in part) and accordingly, transfer the
value/property to other shareholders. For example, a
case of a shareholding distributed equally over two
________________
shareholder groups, i.e., at 50 per cent for each.
A 1:1 rights issue, abstained by one group would
result in the other having a 2/3rd holding. A
higher proportion of ‘rights’ shares (as 2:1, 3:1,
etc.) would yield a more skewed holding in favour
of the resulting dominant group. The Tribunal
observe
no
absurdity
or
unintended
consequences as flowing from the per se
application of Section 56(2)(vii)(c) to right shares,
which by factoring in the value of the existing
holding operates equitably.

Section 55(2)(aa) of the Act clarifies that the
values of the original and the additional financial
assets are interlinked and accordingly, a gain
cannot be computed independent of each other.

In-as-much the value of the additional shares is
derived, if only in part, from that of the existing
shares, the decline in the value thereof cannot be
excluded or ignored in arriving at the property
received by the taxpayer by way of additional
shares. As a result of the transaction, the
taxpayer becomes poorer in-as-much as the
value of his holding witnesses a decline after
taking into account the payment made for the
acquisition of the additional shares.

The receipt of a capital asset is the basis for the
charge to tax as income, unless falling under any
of the excepted categories and therefore, the
receipt (of an asset) has been adopted as the
condition of deeming as income under Section
56(2)(vii)[or clauses (v) and (vi)], and also of the
provision as being on a firm footing.

In the context of Section 56(2)(vii) as well as its
clear language, ‘receipt’ is not a synonym for
‘transfer’ and it flows from its owner. In the
context of the provision, it is completely irrelevant
that the shares in the issuing company are not its
property and that it does not become any poorer
as a result of the allotment of shares therein.
‘Receipt’ is a word or term of wide import, and
would include acquisition of the defined capital
assets in the present context, by modes other
than by way of transfer as well.

To the extent ‘right share’ is allotted to a person
not against his existing shareholding or, even so,
albeit disproportionately, depending on the terms
of the allotment, there is a scope for value or
property being passed on to him, which cannot
be said to be in lieu of or as recompense of his
existing property.
5
Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 (SC), H. Holck Larsen v. CIT
[1972] 85 ITR 285 (Bom)
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
The interpretation made by the Supreme Court in the
case of K.P. Varghese, indicates that the provision6 is
not a charging section. The provision does not deem
as received, something which is in fact not received.
Judicial precedents have held that it is as an antiabuse measure.

To the extent the shares subscribed are right shares,
i.e., allotted pro-rata on the basis of the existing shareholding (as on a cut-off date), the provision though per
se applicable, does not operate adversely. A
disproportionate allotment, though could be allotted
under a rights issue, would however invite the rigor of
the provision to that extent.

The provision was brought as an anti-abuse measure,
only seeks to tax the understatement in consideration
as the income in the hands of the recipient (of the
corresponding asset). The provision is well founded,
even as it is settled that hardship in a case would not
by itself lead to supplying casus omissus or reading
down the provision.

No property is being passed on to the taxpayer in the
instant case, on the allotment of the additional shares.
Accordingly, on the ground of inadequate
consideration the provision of Section 56(2)(vii)(c) of
the Act shall not apply in the present case and, the
difference between the FMV of the shares and the
amount paid to acquire the shares in relation to such
rights shares shall not be assessed as income in the
hands of the taxpayer.
Our comments
This is a welcome decision by the Mumbai Tribunal which
needs
to
be
considered
for
business
restructuring/transactions involving issue of additional
shares.
The Tribunal in the present case held that the shares were
allotted pro-rata to the shareholders of a company based on
their existing holdings and, additional property was not
received by the taxpayer and therefore the difference
between the FMV of the shares and the consideration
received by the company for allotment of such shares
cannot be deemed as income of the shareholder/taxpayer.
This decision may also help firm or a closely held
companies to mitigate the taxability under Section
56(2)(viia)7 of the Act on receipt of shares of a closely held
company.
____________________
6
erstwhile section 52 of the Act
Where a firm or closely held company receives any property being shares of a
closely held company without consideration, the aggregate FMV of which exceeds
fifty thousand rupees, the whole of the aggregate FMV or for a consideration which is
less that aggregate FMV of the property by an amount exceeding fifty thousand
rupees, the difference between such consideration and FMV would be chargeable to
tax under the head of income from other sources
7
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