Section 56(2)(viib) addition deleted where shares issued at premium to existing shareholder

Background and dispute

In Aadinath India Pvt. Ltd. Vs DCIT (ITAT Delhi), the Delhi Bench of the Income Tax Appellate Tribunal examined whether an addition under Section 56(2)(viib) could be sustained where:

Equity shares were issued at a premium to an existing shareholder
Share application money had been received in earlier years
The assessee had independently determined a higher fair market value (FMV) supported by registered valuers

The appeal pertained to Assessment Year 2014-15 and challenged the order of the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi, dated 30.07.2021, which had affirmed an addition of ₹55,55,056 made under Section 56(2)(viib) on account of alleged excess share premium.

The assessee company was engaged in trading of welding rods, air compressors, lubricating oils, bearings and other machinery components.

Facts in brief

During the relevant previous year, the assessee issued:

100,001 equity shares
Face value: ₹10 per share
Premium: ₹115 per share
Issue price: ₹125 per share (₹10 face value + ₹115 premium)

These shares were allotted to M/s Ramgarh Leisure & Entertainment Pvt. Ltd., an existing shareholder of the assessee.

Assessment proceedings

The case was picked up for scrutiny under CASS.
Notice under Section 143(2) was issued on 15.09.2015, followed by subsequent notices.
During assessment, the Assessing Officer (AO) questioned the justification for the premium of ₹115 per share.

Using the Net Asset Value (NAV) method prescribed under Rule 11UA(2) of the Income Tax Rules, the AO:

Determined the FMV at ₹69.45 per share, and
Treated ₹59.45 per share (₹125 – ₹69.45) as excess over FMV
Computed total addition at ₹55,55,056 under Section 56(2)(viib)

According to the AO, the assessee had charged share premium in excess of the FMV and such excess represented income.

Assessee’s valuation approach

The assessee adopted a different approach to determine FMV:

FMV was computed as on the date of allotment of shares, based on:
- Market value of immovable properties
- Valuation of goodwill and other intangible assets

To substantiate the valuation, the assessee placed reliance on:

Valuation report of immovable properties by a registered valuer dated 30.11.2016 (Paper Book pages 26–35)
Separate valuation report of goodwill, also by a registered valuer dated 30.11.2016, valuing goodwill at ₹88,67,183 (Paper Book pages 36–37)

On this basis, the assessee computed:

FMV per share at ₹136
Actual issue price per share at ₹125 (including premium of ₹115)

Thus, as per the assessee, shares were issued below the FMV and no income element arose from the transaction.

Legal contentions before lower authorities

Assessee’s submissions before AO and CIT(A)

The assessee, through its authorised representative, advanced the following arguments:

FMV higher than AO’s NAV-based value
- Under Explanation (a) to Section 56(2)(viib), FMV can be determined either:
  - As per the prescribed method (e.g., NAV under Rule 11UA(2)), or
  - As per a valuation report from a merchant banker/registered valuer following other accepted valuation methods
- Where two values arise, the higher of the two is to be considered as FMV.
- In this case:
  - FMV as per AO (NAV method): ₹69.45
  - FMV as per assessee’s valuation: ₹136
- Since the assessee’s FMV was higher and no defects were pointed out in the valuation reports, that higher value ought to have been adopted, leaving no scope for addition.
Inclusion of goodwill and intangible assets
- The assessee specifically contended that goodwill and other intangibles formed an integral part of business value and were properly quantified by a registered valuer.
- Ignoring such assets, as done by the AO by purely applying a book-value-based NAV, did not reflect the true FMV.