Non-Applicability Of Section 56(2)(x) To Share Buy-Back Transactions

BACKGROUND OF THE CASE

• Globe Capital Market Ltd (‘Assessee’), is engaged in the business of the share broking andclearing of trades.
• During the course of assessment under section 153A of the Income-tax Act, 1961 (‘the Act’), the Assessing Officer (‘AO’) had raised a concern regarding the buyback of shares andinvoked the provisions of section 56(2)(x) of the Act.
• During AY 2018-19, the Assessee undertook buyback of 28,62,500 shares at INR 313.40 per share, aggreagting to INR 89.71 Crores, whereas the Fair market value of each share as perRule11UAoftheIncome-tax Rules, 1962(“the Rules”) was INR370.46.
• Thedifferential amount of INR 57.06 per shares, totalling INR 16.33 Crores was added in the income ofthe Assessee fortheyear under consideration.
• The AO made addition in the hands of the Assessee and held that the Assessee had purchased shares, even though its own shares, which constitute a capital asset as defined under section 56(2)(x) of the Act.
• Beingaggrievedwith AO’sdecision, theAssessee preferred an appeal before the CIT(A).
• Decision of CIT (A): The CIT(A) decisively ruled in favour of Assessee and held that transaction was not a purchase of shares simpliciter but was a purchase of its own shares under buy-back offer, which amounts to reduction of share capital rather than purchase of capital asset.
• Being aggrieved with order of the CIT(A), Tax Department preferred an appeal before Appellate Tribunal.
• Decision of Tribunal: The Tribunal relied upon judgement² of Hyderabad bench of the Tribunal and held that Assessee had purchased its own share and not shares of any other company,provisions of Section 56(2)(viia) of the Act is inapplicable to the facts of the case.
• Aggrieved bytheorder ofTribunal, the Tax Department preferred an appeal before Hon’ble Delhi High Court.
• Learned counsel for the Tax Department argued that the definition of “property” given under section 56(2)(x)(c) of the Act does not create any distinction between the shares of the companyitselfand thesharesof anyother company.
• He further argued that Tribunal relied upon the provisions of 56(2)(viia) of the Act, and Assessee’s case is established under section 56(2)(x) of the Act. He also contended that the scope ofSection 56(2)(x) of the Act is much wider thantheSection 56(2)(viia) of the Act.
• Learned counsel of Assessee argued that buy-back of shares of the company does not amounttopurchaseofanyassetorproperty.

RULING OF HIGH COURT

• Natureof transaction: The HC observed that the Assessee bought back of its own shares pursuant to a buy-back offer made in accordance with law at the price which was fixed by Board of Directors in its meeting. The payment towards buyback of shares was made out of reserves and security premium.
• Buy-back provisions under Companies Act: The HC noted that securities or shares may constitute a property in the hands of a purchaser / subscriber of the said securities / shares. However, for the issuing company, they represent a certificate issued to its members in consideration of their contribution to capital or subscription to shares. Buy back of shares essentially means reduction of capital of the company, which otherwise is impermissible, if recourse to Section 68 of the Companies Act, 2013 is not taken.
• Extinguishment of shares post buy-back: The HC observed that Section 68(vii) of the Companies Act, 2013 mandates that, upon completion of the buy-back, the company must extinguish and physically destroy the shares or security so bought back. The provisions expresses that buy-back of shares is reduction of the share capital.
• Non-applicability of 56(2)(x) of the Act: The HC decisively held in favour of Assessee and stated that the very hypothesis that the Assessee had acquired an asset at a price lower than the fair market value has no legs to stand on. Buy-back of its own shares is antitheses to buying of an asset. The court further observed that the interpretation sought to be placed by AO on section 56(2)(x) of the Act does not hold and the view that a buy-back results in the generation of profit or deemed profit is flawed and untenable in the eye of law.

AURTUS COMMENT

• Delhi High Court’s decision is a welcome development. The applicability of section 56(2)(x) of the Act to share buyback transaction has long been a litigated issue wherein there have already beenseveral tribunal judgements dealing with this matter.
• The decision reinforces the principle that anti-abuse provisions cannot be invoked to override the legal character of a transaction.

Footnotes

1. Globe Capital Market Ltd [TS-529-HC-2026(DEL)]

2. VITP Private Limited, Hyderabad v. DCIT, 2022 (8) TMI 220

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.