Welcome back again…..lets continue the journey from Part II and let us discuss more on 56(2)(viib), with related instructions / notifications!

Before we proceed further, there are couple of notable judgements from Hon'ble ITAT Bangalore, which were pronounced very recently and are quite pertinent to discuss.

1. The judgement in case of M/s. Innoviti Payment Solutions Pvt. Ltd v/s The ITO, Ward - 3(1)(1), [TS-4-ITAT-2019(Bang)], lays down certain crucial guidelines w.r.t additions U/s 56(2)(viib), which are as follows:

The AO should scrutinize the valuation report and he should determine a fresh valuation either by himself or by calling a final determination from an independent valuer and confront the same to the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee.

As per the report of research committee of (ICAI), most critical input of DCF model is the Cash Flow Projections. Hence, the assessee should be asked to establish that such projections by the assessee based on which, the valuation report is prepared by the Chartered accountant, are estimated with reasonable certainty by showing that this is a reliable estimate achievable with reasonable certainty on the basis of facts available on the date of valuation and actual result of future cannot be a basis of saying that the estimates of the management are not reasonable and reliable.

In case of a start up where no past data is available, the view that the projection should be on the basis of reliable future estimate should not be insisted upon because in those cases, the projections may be on the basis of expectations and in such cases, it should be shown that such expectations are reasonable after considering various macro and micro economic factors affecting the business.

Where lot of controversy is revolving around, this is a important judgement of the ITAT, which brings in much required clarity on the subject matter to greater extent.

2. In case of M/s. 2M Power Health Management Services Pvt. Ltd., v/s The ITO, Ward - 7(1)(2) [TS-756-ITAT-2018(Bang)], the ITAT bench restored the matter to CIT(A) for the fresh decision as to whether the premium received is for equity shares to be issued later or for preference shares issued now. By relying on the decisions of Hon'ble Apex court rendered in the case of Rotork Controls India (P) Ltd. as reported in [TS-111-SC-2009-O] and in the case of Bharat Earth Movers vs. CIT as reported in [TS-5116-SC-2000-O], it has been further held that the assessee has to establish that estimation made by the management and given to the Chartered Accountant for certifying DCF is estimated by the management on a scientific basis and therefore, the said estimate is made with reasonable certainty.

Let us now proceed with relevant instructions/notifications from CBDT on the subject matter.

CBDT Instruction - F.No. 173/14/2018-ITA.1, dated 6th Feb, 2018:

When the assessments are done with additions to the returned income and when there is a tax demand, the authorities will certainly initiate the recovery proceeding if the demand is not paid in time. There may be certain instances wherein the assessees prefer to file an appeal before the Commissioner of Income Tax (Appeals), based on the merits.

Even if the taxpayers file an appeal before CIT(Appeals), the tax authorities still insist on the payment of 20% of the disputed demand (please refer CBDT office memorandum dated 31st July, 2017). However, as per the above referred instruction, where the additions are made to the returned income U/s 56(2)(viib) after modifying/rejecting the valuation as per Rule 11UA(2) in case of the "start-up" companies, no coercive measures shall be taken for the recovery of the tax demand. Start-up companies for this purpose means the companies which fall within the definition given in Notification of DIPP, Min. of Commerce & Industry, in G.5.R. 501(E) dated 23.05.2017. The said instruction further states that in all such cases which are pending with the Commissioner (Appeals), necessary administrative steps should be taken for expeditious disposal of appeal ls, preferably by 31" March, 2018.

CBDT Instruction - F.No. 173/14/2018-ITA-I, dated 24th Dec, 2018:

Vide instruction dated 24th Dec, 2018, the CBDT has again directed that the matter is under consideration and no coercive measures to recover the outstanding demand shall be taken in case of start-up's till further instructions are issued in this regard.

CBDT Notification No. 24/2018/F. No.370142/5/2018, dated 24th May, 2018:

CBDT, vide above referred notification, has notified that that the provisions of clause (viib) of sub-section (2) of section 56 of the said Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received for issue of shares from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification under clause (i) of sub-para (3) of para 4 of the Notification number G.S.R. 364(E), dated 11th April, 2018. However, there are certain conditions mentioned in the Notification number G.S.R. 364(E), dated 11th April, 2018, which needs to fulfilled and the same are discussed herein below:

Eligibility:

The company should be a private Limited Company which is recognized as "Start-up" by the Department of Industrial Policy and Promotion (DIPP).

Conditions:

o The aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed ten crore rupees,

o The investor/ proposed investor has:

" The average returned income of twenty-five lakh rupees or more for the preceding three financial years;

or

" The net worth of two crore rupees or more as on the last date of the preceding financial year.

o The startup has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.

Application to the CBDT:

The application for approval has to be made to the Inter-Ministerial Board ('the board") in the Form-2 along with the necessary documents specified therein.

Approval:

The Board may after calling for such documents and making such enquiries as it deems fit,

o Grant approval, specifying the relevant details including details of investor, amount of premium on which shares to be issued and the last date for the issue of shares.

o Reject the application after providing reasons.

Revocation of Approval:

o In case it is found that any certificate has been obtained on the basis of false information, the board can cancel such certificate or approval.

o Where such approval has been revoked, it would be deemed that the certificate or approval has never been granted by the Board.

Thus, from the above, it is quite evident that it's really a cumbersome process to get the benefit of the above referred Notification No. 24/2018/F. No.370142/5/2018, dated 24th May, 2018, since it involves various conditions to be fulfilled and the approval from Inter-Ministerial Board. Further, the notification says that the company should get the valuation report from a merchant banker as per Rule 11UA, which may lead to another round of controversy.

On one hand the government is trying to promote the startup ecosystem, which will bring in new ideas, innovation, employment, etc, but on the other hand there is a uncertainty looming around in the form of so called Angel tax (section 56(2)(viib)). Of course, there has to be strong measures to unearth the unaccounted money, but then it's not fair to look at all the investments from suspicion and bring all such investments into the legal hassle. The issue is further leading to the confusion with divergent decisions coming out from various appellate forums and hence it requires lot of clarity to settle the dust.

Click here to Read Part I of the Article Series

Click here to Read Part II of the Article Series