Analysis, Income Tax, Law & Society

iAnalyze: Section 56(2)(viib) and Section 68

In this edition, Mr. Avnish Arora, and Mr. Dhaval Jariwala shares their views on section 56(2)(viib) and Section 68.

Mr. Arora has worked with large tax and accounting firms including three of the ‘Big Six’ firms. Has advised various companies on a variety of complex international and domestic tax issues and represented corporates before revenue and appellate authorities.

Mr. Jariwala specializes in direct taxation, international taxation, transfer pricing, FEMA, RBI and SEBI laws/ regulations, with a focus on the financial services industry. 

Section 56(2)(viib)

Section 56(2)(viib) comes into play when the transaction of issue of shares is genuine. Finance Act 2012 introduced it to curtail the practice of issuing shares at a very high premium far over its fair market value. Hence what can be added under the provisions of section 56(2)(viib) is the difference on account of valuation.

Section 68

Section 68 comes into play for non-genuine or fake transactions where unaccounted money in the garb of share application is endeavoured to be converted into accounted money using accounting fallacy.

Do you think the tax authorities are likely to apply the anti-avoidance mechanism envisaged under Section 56(2)(viib) more commonly to swap/barter transactions than the mechanism envisaged under Section 68 given the word used in the former is “consideration” rather than “any sum”?

The eleventh edition of Kanga & Palkivala explains the interplay between section 68 and 56(2)(viib) very nicely in following words “This section deals with unexplained cash credits, and, as seen above, includes share application money whose antecedents are not properly explained by the assessee. On the other hand, s 56(2)(viib) deals with consideration received for issue of shares that exceeds the fair market value of shares. Section 56(2) (viib) will apply, therefore, only when the assessee is able to explain the source of the investment. If he is not able to do it, he will be covered by this section and the entire amount received for issue of shares will be chargeable to tax. If he is able to escape the rigours of this section, and explain the investment, he will only be liable under s 56(2)(viib) to the extent that the consideration exceeds the fair market value of such shares. “

Hence, since both the sections, i.e. 56(2)(viib) and 68 operate in different fields and the condition for applicability are different, one cannot say that section 56(2)(viib) will be applied more commonly due to use of the term “consideration” rather than “any sum”.

Also though on a strict interpretation of section 56(2)(viib)  one may apply  the provisions of section 56(2(viib) to a barter transaction, the questions remains how FMV of shares will be valued in such scenarios, i.e. whether the value of the consideration received in-kind can be compared with FMV of shares as per method prescribed.

Considering various judgments, what kind of safety nets could be built in the documentation reflecting share swap/barter transaction? 

The key to all transactions is that they should be genuine and the assessee should be able to explain the rationale behind the swap satisfactorily. If one reads the judgements, where no addition has been made the assessees have been able to explain the rationale, the genuineness of the barter to the authorities. Hence, the best safety is to be ready with a proper explanation as to what prompted the swap, basis for valuation, creditworthiness etc.

Is the risk arising under Section 68 mitigated when transactions take place between two “recognized entities e.g acquisition of business of one DIPP registered start-up by another in consideration of shares? 

We believe to come out of the rigour of section  68 its imperative that the nature, source, basis and the genuineness of any sum credited is  satisfactorily  explained to  the tax authorities.That is  the best mitigation. Other arguments like registration with an authority, absence of consideration in the form of money etc can all follow  and be supportive.

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