DIRECT TAXATION
CRITICAL ISSUES IN
TAXATION
CRITICAL ISSUES
1
SECTION 56(2)(VII)
Individual/HUF
Exclusions:
receives
Sum of Money/Movable
property/Immovable property
Aggregate Value of which
exceeds Rs. 50,000
From any person or
person(s)
•From any relative (In case of HUF: any
member thereof)
•On the occasion of marriage of the
individual.
•Under a will or by way of inheritance
•In contemplation of death of the payer
•From any local authority as defined under
section 10(20)
•From any fund or formation or university
or other educational institution or hospital
or other medical institution or any other
trust or institution referred in Sec 10(23
c)
•From any trust or institution u/s 12AA
2
CRITICAL ISSUES
 Only Individual and HUF covered
 Company and Firm covered u/s sec. 56(2)( viia).
 Private trust/ AOP/ BOI/ co-operative society not
covered.
 Gift on occasion of marriage of individual can be
accepted only by the individual who is getting married.
 Gift received by parents/ guardians fully taxable [
Rajender mohanlal v. DCIT, ITAT- CHD affirmed by Punjab
& Haryana HC]
 Relative: lineal ascendant or descendant (include
maternal side as well as paternal side – Sec. 3F of Hindu
succession act)
3
ISSUES-SEC 56(2)(VII)
1.
Whether Transfer of money or property from a private trust to the beneficiary
would be taxable in the hands of beneficiaries??
2.
If trust is “Determinate” or “Specific Trust”:
Than the money or property actually belong to the beneficiary
in the ratio or specified in the trust deed
If trust is “discretionary trust”:
trustee can not give away properties of the trust to
beneficiaries and can only use trust assets for the benefits of
beneficiaries.
Specific Trust has many advantages
Whether any amount given free of interest without any consideration will
come within the purview of Section 56(2)(vii) ?
The consideration for the interest free loan is the legal commitment
and obligation to return the money and no tax liability emerge.
4
SECTION 56(2)(VII)(A)
Firm/Company (being
closely held company)
receives
Shares of closely held company
from
Any person/persons
With/without consideration
FMV exceeds 50,000
Exclusions:
Transaction not regarded as transfer
under Section 47:
• In Scheme of Amalgamation
(transfer by the amalgamating
company)
• In a Demerger
• Issue of shares by the resulting
company in a scheme of demerger to
the shares of demerged company
• In a scheme of amalgamation
(transfer by the shareholders)
• Shares of predecessor co-operative
bank in consideration of successor
co-operative bank.
5
ISSUES-SEC 56(2)(VII)(A)
1.
Whether issue of fresh shares (Bonus shares/ Right shares/ shares
allotted in a preferential issue) at a price less than the FMV would attract
section 56(2)(vii)(a)??
Bonus Shares:
The consideration is actually reduction in value of original shares
Right Shares:
The shares are issued proportionately to only existing shareholders.
The price at which it is issued could be any price and the same will be FMV as per
valuation principles.
Preferential Issue:
The shares have to be issued at FMV. The Companies Act also require the shares to be
issued based on valuation. In case shares are issued at a price less than Fair Market
Value (FMV) , the section may get attracted.
6
ISSUES-SEC 56(2)(VII)(A)
2.
Whether issue of warrants (which entitles the investor to subscribe for equity
shares) will attract Section 56(2)(vii)(a)??
•Warrants are not shares
•Issuance of warrant will not attract Section 56(2)(vii)(a)
•When Warrants are subscribed/exercised shares have to be issued at
FMV.
Whether issue of debenture (whether convertible/partly convertible/nonconvertible) will attract Section 56(2)(vii)(a)??
3.
•Issuance of bonds are not covered by section 56 (2)(vii)(a)
•Buying and selling of bonds/NCD/OCD/PCD/FCD will not be covered by
the section
•A company buying shares at a price less than FMV will be taxed.
•A company selling shares at beyond FMV will not be taxable till cost plus
index
7
ISSUES-SEC 56(2)(VIIA)
4.
Whether receipt of equity share on conversion of preference
shares/debentures attracts 56(2)(vii)(a)??
Receipt of shares at the time of conversion may not be treated as receipt
of shares for lower consideration as the conversion do not involve “
Received from any person or persons at the date of conversion.
5.
Will section 56(2)(vii)(a) apply if share are settled on a trust if the beneficiary
of the trust is a firm or a company??
This section shall not apply on trust even if the beneficiary of the trust is a
firm or a company or individual or any other person
This section shall be applicable only if the receiver of the shares is a
company or a firm
8
ISSUES-SEC 56(2)(VII)(A)
6.
Will Section 56(2)(vii)(a) apply if shares are distributed by a trust to its
beneficiaries who are firms or companies??
Where the shares are distributed by a trust to its beneficiaries who are
companies/firms Section 56(2)(vii)(a) will be applicable because Section
56(2)(vii)(a) is talking of receipt of shares and not purchase or transferor or
donor.
7.
Transferor or donor can be any person or persons
Will Section 56(2)(vii)(a) apply if shares are received by a trust by purchase
or subscription
Section 56(2)(vii)(a) will have no application
9
ISSUES-SEC 56(2)(VII)(A)
8.
Whether receipt of shares of each individual transaction should be
considered separately or aggregate share of all companies received during
the year ?
EXAMPLE:
Company(Share)
Consideration
FMV
X(1000 Shares)
400*1,000=4,00,000
5,00,000
Y(500 Shares)
NIL
Z(20 shares)
Company
(Shares)
20,000
3,750*20=75,000
Option A
1,00,000
Option B
Option C
X
1,00,000
1,00,000
1,00,000
Y
20,000
NIL
NIL
Z
25,000
NIL
25,000
1,45,000
1,00,000
1,25,000
Incorrect
correct
InCorrect
Taxability
10
ISSUES-SEC 56(2)(VII)(A)
9.
For determining the taxable amount should one aggregate transaction of
inadequate / Nil consideration is considered or aggregate of all transaction
including transaction with adequate consideration??
Adequate Consideration
– separately
(Inadequate consideration– FMV) > 50000
-- separately
Without Consideration , FMV > 50000
– separately
AGGREGATE
INCORRECT
---
11
SECTION 56(2)(VII)(B)
Closely held Company
Exclusions:
receives
Any consideration for issue of shares
on premium
From resident
Aggregate consideration received
exceeds FMV of the shares
Consideration for issue of shares is
received:
• By a venture capital undertaking
from venture capital company or
venture capital fund.
• By a company from a class or
classes of persons as be notified
by the central government in this
behalf.
12
VALUATION OF SHARES : RULE
11 UA
For Section 56(2)(vii) and Section 56(2)(viia)
Quoted Equity Shares
 Transaction through recognised stock exchange
 Transaction value as recorded in such stock exchange
 Transaction through un-recognised stock exchange
 FMV will be
i) The lowest price of such shares and securities on any recognised stock
exchange on the valuation date.
ii) If shares did not trade on the valuation date then the lowest of such
shares on the recognized stock exchange on a date immediately
preceding the valuation date when such shares were traded on such stock
exchange.
Unquoted Equity Shares
FMV
=
(Assets – Liabilities) x Paid up value of such equity share
Total Amount of paid up equity share capital
13
VALUATION OF SHARES : RULE
11 UA
For Section 56(2)(viib)
Option 1 – Same as Section 56(2)(vii) / 56(2)(viia)
Option 2- The Fair market value of the unquoted equity shares determined by a
merchant banker or an accountant as per the discounted cash flow method.
Accountant: Any fellow CA who is not auditor of the company under
section 44AB or statutory auditor whether he is in practice or not.
Treatment of :
Special / Capital/ Revaluation reserves –
DTL/ DTA
Contingent Liability
–
-
Liability excludes Reserves &
surplus by whatever name called.
Not included in asset / liability
Exclude other than arrears
cumulative preference share
dividend
14
ISSUES-SEC 56(2)(IX)
This clause is inserted by Finance Act,2014 w.e.f. 01-04-2015 (Assessment
Year 2015-2016)
(ix) Any sum of money received as an advance or otherwise in the course of
negotiation for transfer of capital asset if,
a) Such sum is forfeited AND
b) The negotiations do not result in transfer of such capital asset.
Consequent Amendment has been made in Sec 51
Such sum shall not be deducted from the cost for which the asset was
acquired or the WDV or the FMV, as the case may, in computing the cost of
acquisition.
15
ISSUES-SEC 56(2)(VIX)
Amt. forfeited - 50,00,000
Original COA – 10,00,000
Old Provision:
Amount forfeited is deducted from COA
, it becomes negative and no treatment
for 40,00,000 has been done.
New Provision:
Amt. Forfeited – 50,00,000
This amt. shall be taxable under income
from other sources.
In the hands of Buyer:
• The amt. forfeited would not be allowed as capital loss.
• If the seller fails to honor the deal and refund back the advance received
as well as compensation, such amt. would be treated as capital gain.
• The Amt. forfeited by the seller shall not be allowed as deduction as
revenue expense because it was for capital asset.
16
SECTION 14(A) : EXPENDITURE INCURRED IN
RELATION TO EXEMPT INCOME NOT INCLUDIBLE IN
TOTAL INCOME
No deduction shall be allowed in respect of expenditure incurred by the assessee in
relation to income which does not form part of total income under this act.
Rule 8D ( inserted vide notification S.O. 547 (E)
Sub Rule (1) Where AO is not satisfied with
 Correctness of the claim of expenditure
 Claim made by the assessee that no expense has been incurred.
He shall determine such expenditure in accordance with the provision of Sub Rule (2).
Expenditure
under Sub
Rule (2) of
8D
Expenditure
directly
related to
exempt
income
For interest paid not
directly attributable to
any income
(A x B / C)
A = Amt. of interest
B = Avg. value of
investment
C = Avg.of total Assets
0.5% of
Average value
of investment
17
SECTION 14(A)- CONSTITUTIONAL VALIDIT Y OF
PROVISIONS
Expenditure would include all forms of expenditure:
Fixed, Variable, Direct, Indirect, Administrative, Managerial or Financial
Kalpataru Construction Overseas Ltd. v/s DCIT [2007]
• Common expenditure incurred cannot be apportioned between taxable and exempt
income on assumption basis
• DLF Ltd. v/s CIT [2009]
There must be a nexus/relation between the expenditure incurred and exempt income
CIT v/s Walfost share and stock P. Ltd. [2010]
• Disallowance under section 14(A) can be made even in a year in which no exempt
income has been earned or received by the assessee.
• Cheminvest Ltd. v/s ITO 121 ITD 318 [2009]
18
SECTION 14(A)-CONSTITUTIONAL
VALIDITY OF PROVISIONS
Provision of section 14 A will apply to all income which is exempt whether the income is
assessed under the head Other sources of PGBP.
Insadallah Investments Ltd. v/s ITO[2008]
• When there is no evidence that borrowed amt. is utilised for investment in tax free
securities and the major investment was made before the date of borrowing – Section
14 A cannot be applied.
• CIT v/s Gujarat Power Corp. Ltd. [2011]
Interest free loan to firm in which assessee was partner, interest paid on borrowed fund was
not allowed u/s 36(i)(iii). Section 14 A applied which prohibited deduction of any
expenditure incurred in relation to income not included in total income
CIT v/s popular Vehicles & services Ltd.[2010]
• Deduction of income derived by the assessee u/s 80HHC(export income), 80P(Cooperative Society). Of the Income tax Act is not a case of exempt income but of
deduction from income .Therefore Sec 14A not applicable.
• ACIT vs Kribhco 006 ITR 686 [2010]
19
SECTION 2(22)(E)- DEEMED
DIVIDEND
Provision:
Dividend includes:
•Any payment by a company not being a company in which the public are substantially
interested of any sum by the way of advance or loan to
Shareholder
•Being the beneficial
owner of shares.
•Holding not less than
10% of voting power
Any concern
Any person
•In which such
Shareholder is a
member/partner
•And in which he has a
substantial interest
•On behalf or for
individual benefit of
any such shareholder
To the extent to which the company possesses Accumulated Profits
20
SECTION 2(22)(E)- DEEMED
DIVIDEND
Dividend under Section 2(22)(e) is taxable in the hands
of:
Shareholder
Such dividends shall be taxable in the hands of the
shareholder normal tax rate u/s 56 of I.T. Act, 1961. at
Company
Shall not required to pay tax on such deemed dividend
u/s 115 O of I.T. Act.
Note: Where as dividend u/s 2(22) (a), (b), (c), or (d) is exempt in the
hands of shareholder u/s 10 (34) , the company shall pay CDT on it u/s
115 O of the I. T. Act.
21
SECTION 2(22)(E)- DEEMED
DIVIDEND
“Substantial Interest” in a concern - as per Explanation 3 of
Sec2(22)(e)
• ... if he is, at any time during the previous year, beneficially entitled to not less than
20% of the income of such concern.
• shares held by a shareholder in his own name and held as guardian to be
considered.
[Case law: CIT vs. Sokkalal (T.P.S.H) 236 ITR 981 (Mad.)(1999)]
To determined the substantial interest of a person in a concern-share held by
him/her in two different capacities, e.g. as individual and as HUF cannot be clubbed.
[Case law: CIT vs. Kunal Organics (P.0 Ltd. 164 taxman 169 [2007] (Ahd.)]
Meaning of “CONCERN” – As per Explanation 3 of sec 2(22)(e)
•HUF
•Sole Proprietor
•Firm
•AOP
•BOI
•Company
22
SECTION 2(22)(E)- DEEMED
DIVIDEND
Following conditions are required to be fulfilled for the
availability of sec 2(22)(e)
•Company- should be one in which the public are not substantially interested
i.e. should be a closely held company.
•Person- should be a shareholder having not less than 10% of voting power.
•Payment- should be by way of advance or loan and made out of
accumulated profits of the company.
•In case loan or advance is to a concern, shareholder should have a
substantial interest in that concern at any time .during the year
23
SECTION 2(22)(E)- DEEMED
DIVIDEND
•Where a loan is advanced to a shareholder, he/it Must be the registered as
well as a beneficial owner of shares. However, where the shareholder is a
beneficial holder but not the registered holder of shares, even then section
2(22) (e) would not attract to him.
[Case law: Rameshwarlal Sanwarmal vs. CIT 122 ITR 1 [1980] (SC)
•Loan to HUF, where members are shareholders .
The Tribunal held that the loan advanced by a private company to HUF of
which the members were directors in the company cannot be deemed as
‘Dividend ’in the hands of HUF as HUF was not a registered shareholder.
ITO v. S.S. Shetty 14 TTJ 71 (Bom) also see Harish ChandGolechav. CIT
[1981] 132 ITR 0030 (Raj).
24
SECTION 2(22)(E)- DEEMED
DIVIDEND
Deemed Dividend u/s 2(22)(e) is taxable in the hands of
Ultimate Recipient of the loan amount...
Deemed dividend can be assessed only in hands of a person who is a shareholder
of lender company and not in hands of a person other than a shareholder.
Deeming fiction of s. 2(22)(e) can be applied only in the hands of the shareholder
and not the non-shareholder [Section 2(22) of the Income-tax Act, 1961
[Sadana Brothers Sales (P.) Ltd. v. Asstt. CIT [2011] 10 taxmann.com 122
(Indore - ITAT)
Company
Loan
Concern
10% or more
voting power
Shareholder
•In the hands of
Shareholders – Taxable
•In the hands of
Concern – Not taxable
Substantial interest
25
SECTION 2(22)(E)- DEEMED
DIVIDEND
If loan amount < Accumulated profits
then entire amount of loan is considered as deemed dividend.
If loan amount> Accumulated Profit,
the amount of loan to the extent of entire Accumulated profits(and not to the
extent of his share in Accumulated profits) will be treated as dividend.
[Case law: CIT v. Arati Debi [1978] 111 ITR 277 (Cal.)]
Duration of loan is not material
Advance towards personal expenses shall be treated as deemed dividend
Loan made by company to the employees i.e. Managing Director assessable in
the hands of shareholder
A loan in kind attract the provisions of deemed dividend-Any payment by a
company of any sum representing a part of the assets by way of advance made
by the company to the shareholder by the transfer of goods would come in to the
provisions of sec. 2(22)(e).
26
[Case law: M.D. Jindal vs. CIT 164 ITR 028 (Cal.)(1987)]
SECTION 2(22)(E)- DEEMED
DIVIDEND
When a Shareholder doing business with company & always having debit
balanextent of Accumulated profits to cover the debit balance, would be
regarded as deemece, the amount would be regarded as loan by the company
and to the d dividend u/s 2(22)(e).
Repayment of an earlier loan could not be adjusted against advancement of
fresh loan, which had been deemed to be dividend under section 2(22)(e) of the
Income-tax Act.
Provisions of Deemed Dividend shall not be applicable to loan received prior
bearing substantial and beneficial interest in a concern.
Ravindra D. Amin v. Commissioner of Income tax[1994] 208 ITR 0815
[Gujarat High Court]
Amount credited to the account by way of interest of loan having opening
balance can not be taxable as deemed dividend.
Sec 2(22)(e) covers only the amount received during the PY by way of
27
loan/advances.
SECTION 2(22)(E)- DEEMED
DIVIDEND
Repayment of loan or any other adjustment- e.g. Remuneration of shareholders
credited to the loan a/c cannot be set off against loan .
Receipt in the nature of share application money cannot be construed as loan or
advance and therefore, it falls beyond the Ken of S. 2(22)(e).
[Case Law : Ardee Finvest (P) Ltd vs. DCIT – ITAT - 70 TTJ (Del) 378]
TDS shall be deducted by the company on such payments.
Amount given as advance for entering in to dealings through shareholder. Could not
be treated as deemed dividend under sec 2(22)(e)
CIT V. Sunil Sethi 26 SOT 95 (ITAT-Del.) (2010)]
Mere book entries do ot constitute payment by the company
CIT vs. Smt. Savithri Sam (1998) 144 CTR (Mad) 17 : (1999) 236 ITR 1003 (Mad.)
Deemed dividend assesses, if any, in the hands of the shareholders in the past AY
should be deducted from the surplus while determining the accumulated profit in the
28
hands of the company
SECTION 2(22)(E)- DEEMED
DIVIDEND
Exceptions to the Section 2(22)(e)
Business Transactions are out of the scope of prov. Of sec. 2(22)(e)
But dividend does not include:
any advance or loan made to a shareholder or the said concern by a company in the
ordinary course of its business, where the lending of money is a substantial part of the
business of the company.
Onus is on the assessee to prove the facts
Walchand & Co. Ltd. V. CIT 100 ITR 598 (1975) (Bom.)]
Trade advances given to the company will not attract 2(22)(e)
Inter Corporate Deposits are different from loans or advances & would not come within
preview of deemed dividend u/s 2(22).
[Case law: Bombay Oil Industries Ltd. V. Dy. CIT 28 SOT 383 (Mum) (2009)]
29
SECTION 2(22)(E)- DEEMED
DIVIDEND
Non taxable accumulated capital gains- distributed to the shareholders of a company
would not be dividend.
Tea Estate India P. Ltd. vs. CIT 103 ITR 0785 (1976) (SC)
Accumulated profit does not include:
Share Premium Account
Share forfeiture receipts
Capital reserve
Subsidy on capital Account
Therefore Dividend can be declared by the company only out of revenue reserves and
not from the capital reserves.
Deemed
dividend in
the hands of
Resident
Shareholder
Non-Resident
Shareholder
30
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
 Any Sum
 Found credited in the book of an assessee
maintained for previous year
 Assessee offers no explanation about the
nature and scope
 OR the explanation offered by him in not in the
opinion of AO, satisfactory
 MAY be charged to Income tax
 As the income of the assessee of that previous
year.
31
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
Provided that where
• Assessee is a company (closely held company)
• And sum so credited consists share application, share capital, share
premium or any such amount
• Explanation offered by assessee company shall be deemed to be not
satisfactory, unless
o the person, being a resident in whose name such credit is recorded
in the books of such company also offers an explanation about the
nature and scope of such sum so credited, AND
o Such explanation in the opinion of AO aforesaid has been found to
be satisfactory.
Provided further that
• first proviso shall not apply if the person in whose name the sum
referred to therein is recorded is Venture capital fund or a Venture
capital company referred in clause (23FB) of section 10.
32
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
Finance Act insert two provisos, w.e.f. 01-04-2013
First Proviso .. Enlarge the onus of closely held company and
provides that if a closely held company receives any share
application money or share capital or premium or like,
Income tax should also establish the SOURSE OF SOURCE
( i.e. resident from whom such money is received.
Second Proviso provides that first proviso will not apply if the
receipt of such sum is from VCF or VCC.
33
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
There must exist books of accounts
 As per Section 2(12A) of Income Tax Act books includes ledgers, day
books, cash books, accounts books and other books.
In Central Bureau of Investigation v. V.C. Shukla [1998] 3SCC
410, the
Supreme Court has held that loose sheets or scraps of
paper cannot be termed as book for they can be easily detached and
replaced.
Books of accounts must be of assessee himself
 Books of account of a partnership firm cannot be considered to be the
books of account of the partner. Any cash credit shown therein cannot
be brought to tax as income under Section 68 in the hands of the
partners.
34
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
Bank Pass book is not books of account for the purpose of Section 68.
 if AO finds any unexplained transaction in the bank passbook of the
assessee then same can be taxed as unexplained money under Section
69A of the act.
Additions in the Partner’s capital account
Issue : whether firm is liable to explain and whether addition can be made to
firm’s income in such case under Section 68 ?
 In CIT v. Metachem Industries [2000] 245 ITR 160(MP), it has been held
that where the assessee-firm had satisfactorily explained the credits
standing in the name of its partners, the responsibility of the assessee
stands discharged.
 It is open to the A.O to undertake further investigation with regard to that
individual who has deposited the amount.
35
CASH CREDIT (SECTION 68 OF INCOME TAX
ACT
Provision applies to all credit entries
 the language of section 68 shows that it is general in nature and applies to
all entries in whomsoever name they may stand, that us whether in the name
of the assessee, or a third party.
 Whether in the revenue nature or capital nature.
 Section does not make any distinction between commercial and non
commercial transactions.
Burden of Proof
In order to discharge the onus, the assessee must prove the following
 the identity of the creditor
The capacity of the creditor to advance money and
Genuineness of the transaction.
Recent Case : [CIT v. Oasis Hospitality Pvt Ltd., 333, ITR, 119, (Delhi HC,2011]
In the comprehensive survey of the law, reiiterated that the initial onus is one
36
the assessee to establish all three of these factors.