ITAT Mumbai: Section 56(2)(viib) Cannot Apply Retrospectively to Share Application Money Received Before Its Enactment — Addition Deleted

Background and Overview

The Mumbai bench of the Income Tax Appellate Tribunal ("ITAT" or "Tribunal") rendered a significant ruling in the case of Savera India Riding Systems Company Pvt. Ltd. Vs DCIT (ITAT Mumbai) concerning the applicability of Section 56(2)(viib) of the Income Tax Act, 1961 to share application money that was received well before the said provision came into force. The Tribunal deleted the addition of Rs. 59,82,060/- made by the Assessing Officer ("AO"), holding that the provision cannot be applied retrospectively to consideration received prior to its statutory insertion.

This ruling carries broad significance for closely held companies that received share application money in earlier years but were compelled — for regulatory or administrative reasons — to defer the actual allotment of shares to a later assessment year.

Case Facts and Background

Nature of Business and Return Filing

The assessee is engaged in the manufacture of Elevator Guide Rails, Fish Plates, and related elevator system components. For Assessment Year 2016-17, the assessee filed its return of income on 30/11/2016, declaring a loss of Rs. 43,72,319. The return was subsequently selected for scrutiny, and notices under Section 143(2) and Section 142(1) of the Income Tax Act, 1961 were duly issued and served.

Share Issuance and Premium Charged

A perusal of the assessee's audited financial statements for the year ending 31/03/2016 revealed that the assessee had issued equity shares to three subscribers — Perfiles Especiales Selak, S.L. (a Spanish company), Mr. V.K. Kothari, and Mr. Girish S. Jain — at a face value of Rs. 10 per share along with a premium of Rs. 30 per share. The aggregate share premium received upon this issuance amounted to Rs. 1,22,08,260.

The details of share allotment and premium received were as follows:

Why the Allotment Was Delayed

The assessee had originally extended a rights issue offer to all its existing shareholders at its Board Meeting held on 29/12/2006, fixing the issue price at Rs. 40 per share — comprising a face value of Rs. 10 and a premium of Rs. 30. While most shareholders declined the offer, the three aforementioned shareholders accepted it and remitted the share application money during the financial years 2006-07 and 2007-08.

Since one of the applicants was a foreign entity, Indian regulations under FEMA mandated that share allotment be completed within 180 days from the date of receipt of application money. The assessee failed to comply with this timeline and was accordingly required to obtain specific approval from the Reserve Bank of India ("RBI") for allotting shares beyond the prescribed period. After a prolonged process, the RBI granted the necessary approval on 15/03/2016, following which the assessee allotted the shares on 28/03/2016 — i.e., during Assessment Year 2016-17.

Valuation Methodology Adopted

The share premium was determined based on a valuation report prepared by a Chartered Accountant on 28/12/2006, applying the Discounted Cash Flow ("DCF") method. The assessee maintained that the issue price of Rs. 40 per share was, in fact, lower than the fair market value as determined by the valuer and was fully substantiated.

Assessment Proceedings and AO's Order

During the course of assessment proceedings, the AO sought detailed justification for the premium charged on shares issued during the year. The assessee provided comprehensive submissions, including:

• That the share application money was entirely received in FY 2006-07 and FY 2007-08, i.e., before Section 56(2)(viib) was inserted in the statute
• That the provisions of Section 56(2)(viib) are inapplicable to a non-resident subscriber (Perfiles Especiales)
• That the premium was determined on the basis of a pre-existing valuation report following the DCF method