Owing to the recent amendments in the tax audit report, the reporting responsibilities of the tax auditor have considerably increased. The revised Form 3CD now requires reporting for receipt of shares of private limited company without consideration or for inadequate consideration and receipt of any consideration for issue of shares which exceeds the fair market value of the shares (i.e. section 56(2)(viia) & 56(2)(viib) of Income Tax Act ). Relevant reporting clauses and other considerations for an assessee and a tax auditor have been discussed in this article.

CLAUSE 28 OF FORM NO. 3CD - UNLISTED SHARES RECEIVED BY COMPANIES/ FIRMs/ LLPsFOR INADEQUATE OR NO CONSIDERATION

Income Tax Act, 1961 (‘Act’) has envisaged taxability on a company/firm/LLP under section 56(2)(viia), whereby shares of unlisted company are received without consideration and the aggregate FMV of such shares received during a previous year exceeds Rs. 50,000 or alternatively, the shares are received for a consideration which is less than the FMV and the aggregate of differences (between FMV and consideration) of all such shares received during a previous year exceeds Rs. 50,000, then such difference is taxable as income under the head ‘income from other sources.

1) This section applies to a closely held company or firm. Firm includes LLP as stated under section 2(23)(i) of the Act. Therefore, section 56(2)(viia) also applies to LLP [Closely held companies are those companies in which public is NOT substantially interested]

2) Unlisted shares shall mean shares of a company in which the public is not substantially interested (a closely held company)

3)These shares may have been received from any person or persons on or after 1^st June, 2010

4)Unlisted shares received shall mean to include equity shares or preference shares 

'Fair market value' (FMV) of a property, being shares of a closely held company, shall be determined in accordance with Rules 11U and 11UA of the Income Tax Rules as provided in Explanation to section 56(2)(vii).

Above taxability is having an exclusion in a case where shares are received by way of a transaction not regarded as transfer under clauses (via)/(vib)/(vic)/(vid)/(vii) of section 47. This clause deals with transfers like in case of amalgamation, demerger, etc. Hence, no tax is attracted under section 56(2)(viia) of the Act for such specified exempt transactions of share transfer.

Clause 28 OF FORM NO. 3CD states as under:

‘Whether during the previous year the assessee has received any property, being share of a company not being a company in which the public are substantially interested, without consideration or for inadequate consideration as referred to in section 56(2)(viia), if yes, please furnish the details of the same.’

Applicability of Clause 28& Reporting Requirements:

Reporting obligation under clause 28 is triggered if the following conditions are satisfied:

a) Assessee is a firm or LLP or a closely held company; and

b) Assessee receives shares of a closely held company during the previous year; and

c) Such shares are received without consideration or for inadequate consideration

If the above conditions are not fulfilled, then tax auditor shall simply state "No" against clause 28. If the above conditions are fulfilled, the tax auditor shall state "Yes" against clause 28 and also furnish details of shares so received.

Clause 28 does not specify what details are to be furnished. It is suggested that the details may be furnished in a format provided in e-filing utility tabulated as under:

Receipt date of the shares can be inferred from the general parlance, i.e., the shares can be said to be received when the recipient company/firm/LLP receives the duly executed transfer deed and the relevant share certificate.

Audit Procedures:

Guidance Note of 2014 on Tax Audit u/s 44AB of the Income Tax Act,1961  has recommended certain procedures which shall be taken care of by Tax Auditor while reporting under this clause:

1) Obtain from the auditee, a list containing the details of shares received, if any, by him from any other company.

2) Verify the same from the books of account-such shares, if received will be reflected either as investments or as stock in trade.

3) In case such shares are received without consideration, the same may not be reflected in the books of account. Verify such shares from the relevant documents such as share certificates issued, if any, demat account statement etc. In either case, the same have to be reported under this clause.

4) For reporting under this clause, the auditor has to consider the provisions of Rule 11UA(1)(c).

5) Auditor should apply procedures set out in Standard on Auditing-620 "Using the work of an Auditor's expert”

6)the auditor should maintain the information in his working paper file for the purpose of reporting in the format provided in the e-filing utility.

OTHER CONSIDERATIONS:

1) It can be argued that, there is no responsibility casted upon an tax auditor to ascertain whether transactions contemplated under 56(2)(viia) of the Act, has taken place during the year, if the same are not reported in the books of accounts by the assessee

2) The details obtained from the assessee should be verified with reference to the books of account, annual reports of companies whose shares have been received, valuation reports, if any obtained from CA or merchant banker under rule 11UA, share purchase agreements etc

3)If shares have been received under exempt transactions, then details of the same are not required to be furnished in clause 28 as the same are outside the purview of section 56(2)(viia)

4) Reporting relating to receipt of shares by an assessee by way of right issue, bonus issue, conversion of debentures, buy back etc, shall be dealt with diligently by the Tax Auditor in light of the Judicial precedents laying down principles on the subject.For example:

i) It was held by the Supreme Court in the case of CIT vs Dalmia Investment Co. Ltd. [TS-4-SC-1964-O] that “bonus shares are shares received 'without payment' and not 'without consideration'.” Thus, it is possible to take a view that section 56(2)(viia)(i) is not attracted in case of receipt of bonus shares by a shareholder.

ii) It was held by the Supreme Court in the case of Khoday Distilleries Ltd. vs CIT [TS-27-SC-2008-O] that “allotment of rights shares by the company involves no transfer” and hence a view can be taken that allotment of rights shares cannot be taxed under section 56(2)(viia)(ii).

CLAUSE 29 OF FORM NO. 3CD - SHARE PREMIUM RECEIVED BY CLOSELY HELD COMPANIES IN EXCESS OF FMV TAXABLE - SECTION 56(2)(viib)

Clause (viib) to sub clause (2) of Section 56 is applicable with effect from Assessment year 13-14. Taxability under the said provision is enacted as under:

1) This section applies to a closely held company (e. 'a company in which the public are NOT substantially interested') receiving any consideration for issue of sharesfrom any resident.

2) These shares received shall include equity shares or preference shares

3) The consideration for the issue of shares exceeds the face value of the shares—in other words, shares are to be issued at a premium

4) The aggregate consideration received for issue of shares exceeds the fair market value of the shares

Such excess over and above the Fair Market Value shall be taxable in the hands of the Company as income under the head ‘Income from other sources’ 

Fair Market Value of the shares shall be determined in accordance with :-

i) such method as prescribed under Rule 11U and Rule 11UA; or

ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher.

The above provisions of clause (viib) are not applicable where the consideration for issue of shares is received

i) by a venture capital undertaking from a venture capital company or a venture capital fund; or

ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

Applicability of Clause 29:

Clause 29 refers to section 56(2)(viib) of the Act. The said section is applicable to a Closely held company Therefore, clause 29 shall apply only to closely held companies.

Reporting Requirements

Reporting obligation under clause 29 is triggered if the following conditions are satisfied:

i) assessee is a closely held company; and

ii) assessee issues shares – whether equity or preference; and

iii) the consideration received for issue of shares exceeds the fair market value as referred to in secton 56(2)(viib)

If the above conditions are not fulfilled, then tax auditor shall simply state "No" against clause 29. If the above conditions are fulfilled, the tax auditor shall state "Yes" against clause 29 and also furnish details of shares so received.

Clause 29 does not specify what details are to be furnished.It is suggested that the details may be furnished in a format provided in e-filing utility tabulated as under

Audit Procedures

Guidance Note of 2014, has recommended certain procedures which shall be taken care of by Tax Auditor while reporting under this clause:

1) Obtain from the auditee, a list containing the details of shares issued, if any, by him to any person being resident

2) Verify the same from the books of account, ROC filings, Balance Sheet - whether there has been any increase in share capital by issue of shares

3) For reporting under this clause, the auditor has to consider the provisions of Rule 11UA(1)(c)(a) or 11UA(2) as may be applicable

4) Auditor should apply procedures set out in Standard on Auditing-620 "Using the work of an Auditor's expert

5) The auditor should maintain relevant information in his working paper file for the purpose of reporting in the format provided in the e-filing utility.

OTHER CONSIDERATIONS:

1) Class of company as closely held company at the time of receipt of consideration shall be relevant rather than actual allotment of shares.

2) Status of the investor as ‘Resident’ is relevant at the time of infusion of money. Subsequent change in residential status at the time of allotment of shares to him should assume no relevance.

3) Although the wording of provisions specific ‘any consideration received for issue of shares’, the word “any” would mean to include both cash and kind considerations in its wider scope. However, the Memorandum to Finance Act at the time of introduction of this provision has clearly stated its intention to target cash transactions and hence, it can be argued that the provision should not apply to considerations received in kind for issue of shares.

4) Applicability/taxability under this provision shall be invoked ipso facto during the year of receipt of consideration. However, subsequent event of non-allotment of shares/refund of monies is not dealt with.