Share Transfer with no consideration chargeable to Income Tax

Shares: Statutory Definition

According to Section 2(84) a share may be defined as a share capital of a company and it includes stocks. All shares of the company must have a distinctive number.

Shares are also regarded as movable property by Section 2 of the Sales of Goods Act 1930. Shares can therefore be also considered “Goods”. Thus rules related to passing of ownership in goods would be applicable in case of transfer of shares. Shares can also be pledged like other goods. 

Transferability of shares

Under Section 44 of the Companies Act, 2013, shares are to be regarded as movables property, transferable in the manner provided by the articles of the company. Thus, a share is a right to a specified amount of share capital of a company, carrying with it certain rights and liabilities, both when the company is a going concern and also when it is wound up. It represents the interest of the holder measured for purposes of liability and dividend by a sum of money.

In the case of T.A.K. Mohideen Pichai Taroganau v. Tinnevelly Mills Co. Ltd. [AIR 1928 Mad 571] it was held that every share carries with it certain rights and liabilities in respect of the company. It is recognized as movable property which can be freely transferred in the manner provided for, and subject to any restriction, if any, under the articles of the company. The attribute of transferability being statutorily conferred on shares, in no event can a company whether public or private, absolutely restrict transfer of shares either expressly or impliedly. 

Share Capital

Although most companies are incorporated with a share capital, every company need not have a share capital, as this is not a necessary ingredient of incorporation. A company may be registered without share capital, as for instance, a company limited by guarantee. 

The share capital of a company must be divided into shares of equal amounts. The maximum amount of share capital that a company can raise is mentioned in the memorandum of the company. This is called the authorised or registered or nominal share capital of the company and the company cannot raise any capital exceeding this amount without first amending the memorandum to show the increased amount in the memorandum. 

Share Transfer with no consideration chargeable to Income Tax

The issue was dealt recently in the case of Shri Rajeev Ratanlal Tulshyan v. Income Tax Officer [I.T.A. No.5748/Mum/2017 & Cross Objection No. No.118/Mum/2018 AY 2014-2015 judgment dated 1st October 2021]. We shall discuss the facts, issue and decision of the ITAT on the said issue.

Facts of the case 

The Appellant was a director and he was a major shareholder in M/s Kennington Fabrics Private Limited. The company offered the right issue and Rs. 3.95 Crores shares of the company were allotted to the appellate at face value of Re. 1/- each in the right issue.

The AO stated that the consideration of Re. 1/- per share was below than the Fair Market Value of shares as calculated as per Section 56(2) (vii) (c) (ii) of the IT Act read along with Rule 11U & 11UA of IT Rules, 1962. Hence, the difference between Fair Market Value and the consideration paid by the Appellant would be taxable.

What is the provision of the IT Act, Section 56(2)(vii)?

It is an anti-abuse provision that was inserted after repealing the Gift Tax Act. In a circular dated 3rd June 2010, i.e. the CBDT Circular No. 05/2010 provided that Section 56 of the IT Act is being introduced as an anti-abuse measure.

Another circular dated 6th April 2011 i.e. the CBDT Circular No. 01/2011 also provided that these provisions are anti-abuse provisions and transferring of shares of a company to a firm or a company, instead of an individual or a Hindu Undivided Family (HUF), without consideration or at a lower FMV does not attract the anti-abuse provision.

Decision of the Commissioner of Income Tax (Appeals)

The Commissioner of Income Tax (Appeals) [CIT(A)], ruled that that Share Transfer without consideration or at a price lower than Fair Market Value (FMV) is chargeable to income tax. An appeal was made against the order of the CIT(A).

Decision of the Appellate Tribunal

The coram headed by the Vice President, Mahavir Singh, and Accountant Member, Manoj Kumar Aggarwal relied upon DCIT V/s Dr. Ranjan Pai [431 ITR 250/197 DTR 314/ 318 CTR 603/ 278 Taxman 138 (Karn) (HC)] and observed that the intent of introducing the provisions was anti-abusive measures still remain intact. The provisions of the IT Act were a counter evasion mechanism that aims to prevent the laundering of unaccounted income. Hence, the shares are allotted genuinely to the shareholders than it shall be considered valid.

The Income Tax Appellate Tribunal (ITAT) held that transferring of share without consideration or transferring at a lower price than Fair Market Value is chargeable to income tax. It further clarified that transfer of shares of a company to a firm/ company, and not to an individual or a HUF, without consideration or at a lower FMV would not attract Section 56(2)(vii) of the IT Act.