THERMODYNE DYNAMICS PRIVATE LIMITED,HYDERABAD vs. INCOME-TAX OFFICER, WARD -17(3), HYDERABAD

Succinctly stated, the assessee company had filed its return of income for A.Y. 2013-14 on 29.09.2013, declaring an income of Rs.4,91,280/-. Subsequently, the case of the assessee company was selected for scrutiny assessment under Section 143(2) of the Act.

On a perusal of the record, the A.O. further observed that the assessee company had during the subject year acquired 3,15,00,000 shares of M/s. Kineta Global Limited at a face value of Rs.10/- each. On verification, the A.O. observed that M/s. Kineta Global Limited (supra) as per its “balance Sheet” on 31.03.2012 had reserves of Rs.17,40,05,443/-. The A.O. was of the view that if the reserves were distributed amongst the existing shareholders on 31.03.2012 then the premium on each share of the face value of Rs.10/- would work out at Rs. 5.80 per share. Accordingly, the A.O. based on his aforesaid observation held a firm conviction that though the value of the shares of the aforementioned company along with the premium worked out at Rs.15.80 per share, but, the assessee company had received the same at Rs.10/- per share. The A.O. based on his aforesaid observation called upon the assessee company to explain that as it had received the shares of the aforesaid company for a consideration which was less than its aggregate Fair Market Value (for short, “F.M.V.”), therefore, why an addition under Section 56(2)(viia) of the Act be not made in its case. In reply, the assessee 5 Thermodyne Dynamics Private Limited Vs. ITO company objected to the addition proposed by the A.O for reasons as under (extracted from the assessment order):

Since, the allotment of shares is in pursuance of pursuance and in furtherance of an agreement that has been in force prior to the amendment of the section and therefore the provisions of the section are not applicable. d) In case of subscription there is no income at all being generated and the issuer is not liable to pay any tax on the amount received from the subscriber. Accordingly, the question of preventing leakage of income or erosion of tax base does not rise. The mischief sought to be addressed by sec. 56(2)(viia) is not possible in the case of fresh allotment. e) The assessee relied on decision of Hon'ble Supreme Court in the case of Khoday Distelleries Ltd., 3071TR312 wherein the 6 Thermodyne Dynamics Private Limited Vs. ITO Hon'ble Supreme Court explained difference between 'creation' and 'transfer'. f) The intention of the parties of the allotment of shares is to make Kineta Global Limited a subsidiary company and the assessee had extended all support which a holding company would extent to a subsidiary. The assessee has allowed the use of land and also provided the land as security for the amounts borrowed by Kineta Global Limited.”

However, the aforesaid explanation of the assessee company did not find favour with the A.O. The AO held a firm conviction that the difference in the F.M.V. of the shares of M/s. Kineta Global Limited (supra) as against the value for which the assessee company had received the same was liable to be brought to tax under Section 56(2)(viia) of the Act. Accordingly, the A.O determined the F.M.V of the subject shares as per Rule 11UA of the Income-tax Rules, 1962at Rs.15.82 per share and made an addition in the hands of the assessee company of Rs. 18,03,62,857/- (i.e 3,10,00,000 shares X Rs.5.82 per share) under Section 56(2)(viia).

Shri Pawan Kumar Chakrapani, C.A. - the learned Authorized Representative (for short “ld.AR”) for the assessee company, at the threshold of hearing of the appeal, submitted that the A.O. had grossly erred in law and on the facts of the case in invoking the provisions of Section 56(2)(viia) of the Act. Elaborating on his contention, the Ld. AR submitted that the assessee company; M/s.

Coming back to the issue in hand, i.e. application of the provisions of Section 56(2)(viia) of the Act, the Ld. AR submitted that the same had been made available on the statute by the legislature vide the Finance Act, 2010 w.e.f. 01.06.2010. The Ld. AR submitted that as the assessee company had already vide the aforesaid “agreement”, dated 18.02.2010 (supra) agreed to subscribe to the shares of the company, viz. M/s. Kineta Metals and Minerals Limited (supra), i.e. at a time when Section 56(2)(viia) of the Act was not available on the statute, therefore, there was no justification for the A.O. to have invoked the same and made a consequential addition in the hands of the assessee company.

Alternatively, the Ld. AR submitted that as it was a case of a fresh allotment of shares and not a transfer of shares, therefore, for the said reason also the provisions of Section 56(2)(viia) of the Act could not have been invoked. The Ld. AR to buttress his aforesaid claim had drawn support from the judgment of the Hon’ble Supreme Court in the case of Khoday Distilleries Ltd. Vs. CIT & Anr. (2008) 307 ITR 312 (SC) and that of the Hon'ble High Court of Gujarat in the case of PCIT Vs. Jigar Jashwantlal Shah 12 Thermodyne Dynamics Private Limited Vs. ITO

Apropos the disallowance made by the A.O. under Section 14A of the Act, the Ld. AR submitted that as the assessee company during the subject year had not received any exempt income, therefore, the A.O. could not have worked out any disallowance as per the pre-amended Section 14A of the Act. The Ld. AR in support of his aforesaid contention had relied on the judgment of the 14 Thermodyne Dynamics Private Limited Vs. ITO Hon'ble Supreme Court in the case of CIT Vs. Chettinad Logistics (P) Ltd. (2018) 95 Taxmann.com 250 (SC). It was, thus, the Ld. A.Rs claim that the A.O. in the absence of any exempt income having been received by the assessee company during the subject year had grossly erred in law and facts of the case in making disallowance under Section 14A of the Act.

Per contra, the learned CIT-DR (for short “ld. DR”) relied upon the orders of lower authorities. The Ld. DR submitted that the A.O. as per the CBDT Circular No.5/2014 (F.No.225/182/2013-ITA- III), dated11.02.2014 had rightly made the disallowance in the hands of the assessee company under Section 14A of the Act.

Apropos the addition made by the A.O. u/s 56(2)(viia) of the Act, the Ld. DR submitted that as the “agreement”, dated 18.02.2010 relied upon by the assessee’s counsel, in his attempt to impress that the assessee company had agreed to subscribe to the shares of the aforementioned company viz., M/s. Kineta Metals and Minerals Limited (supra) before the insertion of Section 56(2)(via) w.e.f 01.06.2010 was not even notarized much the less registered, thus, the same does not inspire any confidence 15 Thermodyne Dynamics Private Limited Vs. ITO regarding the authenticity of the same. Apart from that, the Ld. DR submitted that Section 56(2)(viia) of the Act that has been made available on the statute w.e.f 01.06.2010 provides that where a company receives, in any previous year, from any person or persons, on or after 01.06.2010, any property, being shares of the company, viz. (i). without consideration; or (ii). for a consideration which is less than its F.M.V.; then the deeming provisions therein contemplated would come into play. Elaborating further on his contention, the Ld. DR submitted that the receipt of shares by the assessee company in the present case before us i.e. after 01.06.2010, sufficed the invocation of the provisions of Section 56(2)(viia) of the Act. The Ld. DR submitted that Section 56(2)(viia) does not carve out any exception to its invocation, on the pretext, that though shares were allotted on or after 01.06.2010 (supra) but the share allotee had before the aforesaid cut-off date i.e 01.06.2010 (supra) entered into an agreement and parted with amount towards share application money. To sum up, the Ld. DR submitted that neither the “agreement”, dt.18.02.2010” inspires any confidence regarding its 16 Thermodyne Dynamics Private Limited Vs. ITO authenticity; nor the claim of the assessee’s counsel that as the assessee company had before the insertion of Section 56(2)(viia) of the Act i.e w.e.f. 01.06.2010 agreed to subscribe to the shares of the company has any substance, therefore, the A.O has rightly invoked the said section and made addition in the hands of the assessee company.

Apropos the claim of the assessee’s counsel that the provisions of Section 56(2)(viia) of the Act were not applicable in the case of a fresh allotment and are applicable only in case of transfer of shares, the Ld. DR submitted that nothing to the said effect can be gathered from a plain literal interpretation of the said statutory provision. The Ld. DR submitted that as Section 56(2)(viia) of the Act has been made available on the statute to discourage share transactions at a suppressed value, therefore, the fine distinction attempted to be drawn by the assessee’s counsel between a “fresh allotment” vis-a-vis “transfer of shares” is devoid and bereft of any substance.

We have heard the learned Authorized Representatives of both parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by them to drive home their respective contentions.

We find substance in the Ld. AR’s claim that as the assessee company has during the subject year not received any exempt income, therefore, as per the pre-amended Section 14A of the Act i.e. as was available on the statute before its amendment vide the Finance Act, 2022 w.e.f 01.04.2022, in the absence of receipt of any exempt income no disallowance u/s 14A of the Act could have been made in the hands of the assessee company. Our aforesaid view is fortified by the judgment of the Hon'ble High Court of Madras in the case of Commissioner of Income Tax Vs. Chettinad Logistics Pvt. Ltd. (2017) 248 Taxman 55 (Mad.). The Special Leave Petition (SLP) (Civil) No.16194 of 2018 filed by the department before the Hon'ble Apex Court against the aforesaid order of the Hon'ble High Court of Madras in the case of Chettinad Logistics Pvt. Ltd. (supra) has been dismissed by the 18 Thermodyne Dynamics Private Limited Vs. ITO Hon'ble Apex Court in CIT Vs. Chettinad Logistics (P) Ltd. (2018) 95 taxmann.com 250 (SC). Rather, we find that even the review petition filed by the revenue has also been dismissed by the Hon'ble Apex Court vide its order passed in Commissioner of Income Tax (Central) Vs. M/s. Chettinad Logistics Pvt. Ltd. (2019) 105 CCH 226 (SC). Also, we find that the Hon'ble Apex Court has taken the same view in the case of Principal Commissioner of Income Tax Vs. Oil Industry Development Board (2019) 262 Taxman 102 (SC), wherein the order of the Hon'ble High Court of Delhi in the case of Principal Commissioner of Income Tax Vs. Oil Industries Development Board (2018) 101 CCH 452 (Del. HC) was approved.

We thus, in terms of our aforesaid deliberations, are of the firm conviction, that pursuant to the aforesaid orders of the Hon'ble Supreme Court the issue involved in the present appeal is no more res integra. Although, we principally agree with the Ld. AR that in the absence of receipt of any exempt income during the subject year no disallowance under the pre-amended Section 14A of the Act could have been made by the A.O., but the fact that the 19 Thermodyne Dynamics Private Limited Vs. ITO assessee company has during the subject year not received any exempt income cannot safely be gathered from the record. Accordingly, we herein set aside the matter to the file of the A.O. with a direction to verify the veracity of the aforesaid claim of the assessee company and if the same is found to be in order, then, delete the disallowance of Rs. 15.75 lacs made by him under Section 14A of the Act.

We shall now deal with the claim of the Ld. AR that as the assessee company has not received any shares from any person or persons but on the contrary, the shares of the aforesaid company viz. M/s. Kineta Metals and Minerals Limited (supra) were issued to the assessee company during the process of share allotment, therefore, it being a case of fresh allotment of share capital and 23 Thermodyne Dynamics Private Limited Vs. ITO not a transfer of existing shares from an existing shareholder, the provisions of Section 56(2)(viia) of the Act could not have been invoked in its case.

We have thoughtfully considered the contentions advanced by the Ld. Authorized Representatives of both parties in the backdrop of the orders of the lower authorities. It is the claim of the Ld. AR that the provisions of Section 56(2)(viia) that have been made available on the statute vide the Finance Act, 2010, w.e.f 01.06.2010 are applicable only in the case of “transfer” of shares and not in a case of a “fresh allotment”. On a perusal of Section 56(2)(viia) of the Act, we find that the same is applicable where a firm or company, not being a company in which the public are substantially interested, receives, in any previous year, from any person or persons, on or after the 1st day of June, 2010 [but before the 1st day of April, 2017], any property, being shares of a company not being a company in which the public are substantially interested, viz. (i). without consideration; or (ii). for a consideration that is less than the FMV of such property. We find substance in the Ld. AR’s claim that as Section 56(2)(viia) has as a pre-condition 24 Thermodyne Dynamics Private Limited Vs. ITO of receipt of shares by an assessee, i.e a firm or company (not being a company in which public are substantially interested), therefore, the said shares must be in existence failing which the section in itself will be rendered as unworkable. We find that the Hon’ble Supreme Court in the case of M/s Khoday Distilleries Ltd. Vs. CIT & Anr. (2008) 307 ITR 312 (SC), has held that there is a difference between the issue of a share to a subscriber and the purchase of a share from an existing shareholder. The Hon'ble Apex Court after drawing support from its earlier order in the case of Sri. Gopal Jalan & Company Vs. Calcutta Stock Exchange Association Ltd. 1964 (3) SCR 698, has observed that it is only on “allotment” that the shares come into existence, and till such an allotment the shares do not exist at all. Further, it was observed that “allotment” indicates the creation of shares by appropriation out of the unappropriated share capital to a particular person and that such creation does not amount to transfer. We thus, in the backdrop of the aforesaid settled position of law are of the firm conviction that the allotment of 3,15,00,000 shares of M/s. Kineta Metals and Minerals Limited (supra) to the assessee company on 25 Thermodyne Dynamics Private Limited Vs. ITO 02.07.2012 (supra), i.e creation of shares by appropriation out of the unappropriated share capital cannot be brought within the meaning of receipt of shares, which is a pre-condition for invoking the provisions of Section 56(2)(viia) of the Act.

We further find that our aforesaid view that the provisions of Section 56(2)(viia) of the Act cannot be invoked regarding the fresh allotment of 3,15,00,000 shares of M/s. Kineta Metals and Minerals Limited (supra) to the assessee company on 02.07.2012 is supported by the judgment of the Hon'ble High Court of Gujarat in the case of Pr. CIT Vs. Jigar Jashwantlal Shah (2024) 460 ITR 628 (Guj). The indulgence of the Hon'ble High Court in the aforementioned case was, inter alia, sought by the revenue for adjudicating the scope of a similarly worded Section 56(2)(vii)(c) of the Act on the following question of law:-

On appeal, the Hon'ble High Court by drawing support from the judgment of the Hon’ble Supreme Court in the case of M/s Khoday Distilleries Ltd. Vs. CIT & Anr. (2008) 307 ITR 312 27 Thermodyne Dynamics Private Limited Vs. ITO (SC) and the “Explanatory notes” to the Finance Bill, 2010, inter alia, observed that as the shares had come into existence only when the allotment was made by the company as right shares, therefore, the same could not be said to have been "received from any person", which was the fundamental requirement for invoking the provisions of Section 56(2)(vii)(c) of the Act. The Hon'ble High Court was of the view that the intention of the legislature that the property must pre-exist for triggering the provisions of Section 56(2)(vii)(c) of the Act could safely be gathered from the words used in the said statutory provision. For the sake of clarity, the observations of the Hon’ble High Court are culled out as under (relevant extract) : "6. Sec.56(2)(vii)(c) of the Act, reads as under:

The aforesaid provision of Sec.56(2)(vii)(c) of the Act was inserted vide amended Act with effect from 01.07.2010. Explanatory notes explaining the provisions of Finance Bill reads as under: "Taxation of certain transactions without consideration or for inadequate consideration Under the existing provisions of section 56(2)(vii), any sum of money or any property in kind which is received without consideration or for inadequate consideration (in excess of the prescribed limit 30 Thermodyne Dynamics Private Limited Vs. ITO of Rs.50,000) by an individual or an HUF is chargeable to income-tax in the hands of recipient under the head 'income from other sources'. However, receipts from relatives or on the occasion of marriage or under a will are outside the scope of this provision. The existing definition of property for the purposes of section 56(2)(vii) includes immovable property being land or building or both, shares and securities, jewellery, archeological collection, drawings, paintings, sculpture or any work of art. A. These are anti-abuse provisions which are currently applicable only if an individual or an HUF is the recipient. Therefore, transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value does not attract the anti-abuse provision. In order to prevent the practice of transferring unlisted shares at prices much below their fair market value, it is proposed to amend section 56 to also include within its ambit transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where the recipient is a firm or a company (not being a company in which public are substantially interested). Section 2(18) provides the definition of a company in which the public are substantially interested. It is also proposed to exclude the transactions undertaken for business reorganization, amalgamation and demerger which are not regarded as transfer under clauses (via), (vic), (vicb), (vid) and (vii) of section 47 of the Act. Consequential amendments are proposed in- (i) section 2(24), to include the value of such shares in the definition of income; (ii) section 49, to provide that the cost of acquisition of such shares will be the value which has been taken into account 31 Thermodyne Dynamics Private Limited Vs. ITO and has been subjected to tax under the provisions of section 56(2). These amendments are proposed to take effect from 1st June 2010 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years. B. The provisions of section 56(2)(vii) were introduced as a counter evasion mechanism to prevent laundering of unaccounted income under the garb of gifts, particularly after abolition of the Gift Tax Act. The provisions were intended to extend the tax net to such transactions in kind. The intent is not to tax the transactions entered into in the normal course of business or trade, the profits of which are taxable under specific head of income. It is, therefore, proposed to amend the definition of property, so as to provide that section 56(2)(vii) will have application to the 'property' which is in the nature of a capital asset of the recipient and therefore would not apply to stock-in-trade, raw material and consumable stores of any business of such recipient. C. In several cases of immovable property transactions, there is a time gap between the booking of a property and the receipt of such property on registration, which results in a taxable differential. It is, therefore, proposed to amend clause (vii) of section 56(2) so as to provide that it would apply only if the immovable property is received without any consideration and to remove the stipulation regarding transactions involving cases of inadequate consideration in respect of immovable property. These amendments are proposed to take effect retrospectively from 1st October, 2009 and will, accordingly, apply in relation to the assessment year 2010-11 and subsequent years. D. It is proposed to amend the definition of 'property' as provided under section 56 so as to include transactions in respect of 'bullion'. This amendment is proposed to take effect from 1st June, 2010 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years. E. It is proposed to amend section 142A(1) to allow the Assessing Officer to make a reference to the Valuation Officer for an estimate 32 Thermodyne Dynamics Private Limited Vs. ITO of the value of property for the purposes of section 56(2). This amendment is proposed to take effect from 1st July, 2010."

Conjoint reading of the provision as well as the explanatory note of the said provision, it is clear that only when an individual or a HUF receives any property for consideration which is less than the FMV, the provisions of Sec.56(2)(vii)(c) would be attracted. In the facts of the case, the shares had come into existence only when the allotment is made by the company as right shares cannot be said to be "received from any person". The shares which have been allotted to the assessee were not "received from any person" which is the fundamental requirement for invoking sec.56(2)(vii)(c). In other words, the property must pre-exist for application of Sec.56(2) (vii)(c), which is clear from the intention of the legislature. **** **** **** 18. In view of the above, the provisions of Sec.56(2) would not be applicable to the issue of new shares which is also submitted by the explanatory notice to the Finance Bill, 2010, wherein, it is clarified that sec.56(2)(vii)(c) of the Act ought to be applied only in the case of transfer of shares. It is trite law that allotment of new shares cannot be regarded as transfer of shares. Therefore, in order to apply the provisions of sec.56(2)(vii)(c), there must be an existence of property before receiving it. As per advanced Law Lexicon Dictionary, the tern "receive" has been defined as "To receive means to get by a transfer, as to receive a gift , to receive a letter or to receive money and involves an actual receipt." Issu of new shares by company as a right shares is creation of property and merely receiving such shares cannot be considered as a transfer under Sec.56(2)(vii)(c) and accordingly, such provision would not be applicable on the issuance of shared by the Company in the hands of the allottee.

The Apex Court in the case of Khoday Distilleries Ltd. vs. CIT reported in [2008] 307 ITR 312 (SC) (176 Taxmann 142)], after referring to the decision in the case of Shri Gopal Jalan & Co. vs. Calcutta Stock Exchange Association Ltd., reported in 1964 (3) SCC 698, noted the question arose as to the amendment of the word "allotment" held that the word "allotment" means appropriation out 33 Thermodyne Dynamics Private Limited Vs. ITO of previously unappropriated capital of a company, of a certain number of shares to a person and till such allotment, the shares do not exist as such". Therefore, it is only on allotment that the shares come into existence. In every case, the words "allotment of shares" having used to indicate the creation of shares appropriation out of unappropriated share given to a particular person which is also referred to in the notice of clause to the Finance Bill 2010. Therefore, the aim and intention behind amending the provision of Sec.56 is to prevent the practice of transferring unutilized shares at a price which are allotted for the first time by way of right shares. The amendment is therefore never meant to aim the "fresh issue" or "fresh allotment" of shares by a company. **** **** **** ” (emphasis supplied by us)

We thus, in the backdrop of the aforesaid settled position of law, i.e a fresh allotment of shares is a mere creation of such shares, which cannot be brought within the meaning of “receipt of shares” under Section 56(2)(viia) of the Act; read alongwith the “Explanatory Notes” to the Finance Bill, 2010 (explaining the purpose and intent of inserting Section 56(2)(viia) of the Act) are of the firm conviction that the transaction of allotment of 3,15,00,000 nos. of equity shares of M/s. Kineta Metals and Minerals Limited (supra) to the assessee company at a face value of Rs.10/- per share will not be hit by the provisions of Section 56(2)(viia) of the 34 Thermodyne Dynamics Private Limited Vs. ITO Act. The Grounds of appeal Nos.5 and 6 are partly allowed in terms of our aforesaid observations.

The Grounds of appeal Nos.1, 2, 8 and 9 being general in nature are dismissed as not pressed.

Resultantly, the appeal filed by the assessee company is partly allowed in terms of our aforesaid observations.