The Delhi High Court has clarified that once the shares are bought back, the purported property extinguishes. Hence, a person cannot be taxed for so-called deemed profit from the property (shares) which accrues to it consequent to destruction of the very same property.
Hence, the very hypothesis that the respondent-company (assessee) had acquired an asset at lesser rate than the fair market value has no legs to stand on, as buy-back of its own shares is antitheses to buying an asset. Accordingly, the action of the AO in treating the buy-back of shares of the company to be a transaction leading to generation of profit/deemed profit is clearly flawed and untenable in the eye of law.
The Division Bench comprising Justice Dinesh Mehta and Justice Vinod Kumar recorded that the company had purchased its own shares pursuant to a buyback offer made in accordance with law, at a rate fixed by the Board of Directors and duly approved by the shareholders, and that the payment was made out of free reserves and securities premium.
The Bench examined Section 68 of the Companies Act, 2013 and described it as the “fountain head” under which a company can purchase its own shares. The Court reproduced the statutory framework showing that buyback is permitted only in the manner and subject to the conditions prescribed under Section 68, including source of funds, authorization, limits, solvency compliance, extinguishment of shares, and post-buyback filings.
The Bench observed that for Section 68 of the Companies Act and the procedure provided thereunder, there is no way a company can buy its own shares, because buying its own shares is otherwise alien to the concept of a corporate entity and the provisions of company law. It further observed that while securities or shares may in a given case be property in the hands of a corporate entity, for the issuing company they are merely certificates issued to members in lieu of capital contribution or subscription to shares.
The buyback of shares essentially means reduction of capital of the company, which otherwise would be impermissible unless recourse is taken to Section 68 of the Companies Act. This understanding formed the central basis for distinguishing a buyback from acquisition of a capital asset or property by the issuing company, added the Bench.
The Bench placed particular emphasis on Section 68(7) of the Companies Act, which mandates that after completion of buyback, the company shall extinguish and physically destroy the shares or securities so bought back. On that basis, it observed that Section 68 itself, in so many words, expresses that buyback of shares is reduction of share capital.
Lastly, the Bench noted that the Department’s interpretation of Section 56(2)(x), though attractive at first blush, did not survive scrutiny when tested on the principles of the Companies Act, common prudence, and the provisions of the Income Tax Act. Thus, the Court rejected the Revenue’s submission that the definition of “property” under Section 56(2)(x) covered even a company’s own shares in the context of buyback.
Briefly, the respondent-assessee was engaged in the business of share broking and clearing of trades. During assessment proceedings under Section 153A of the Income Tax Act, the Assessing Officer raised an issue regarding the buyback of shares and invoked Section 56(2)(x) of the Act. For AY 2018-19, the assessee company had bought back 28,62,500 equity shares for a total consideration of Rs. 89.71 crores, whereas the fair market value of each share, as computed under Rule 11UA of the Income Tax Rules, 1962, was Rs. 370.46 per share. On this basis, the Assessing Officer computed a difference of Rs. 57.06 per share and made an addition of Rs. 16.33 crores to the income of the assessee under Section 56(2)(x).
The assessment order was passed under Sections 153A/143(3) of the Income Tax Act, determining the total income of the assessee at Rs. 126.96 crores, inclusive of the said addition. The Assessing Officer’s reasoning was that the shares purchased by the company, though its own shares, constituted a capital asset/property under Section 56(2)(x), and since they were purchased below fair market value, the differential amount was taxable in the hands of the assessee.
On appeal, the CIT(A) held that the impugned transaction was not a purchase of shares simpliciter, but a purchase by the company of its own shares under a buyback offer, which amounted to reduction of share capital rather than purchase of a capital asset. On further appeal, the ITAT also held that since the assessee had purchased its own shares and not shares of another company, Section 56(2)(viia) was inapplicable.
Appearances:
Advocates Vipul Agrawal, Lakshi Shriwal, Harshita Kotru and Gaoraang Ranjan, for the Appellant/ Revenue
Advocates Sumit Lalchandani and Ananya Kapoor, for the Respondent/ Taxpayer
