The New Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that where the Compulsory Convertible Preference Shares (CCPS) are issued by the subsidiary (assessee) to its parent/holding company and existing shareholders pursuant to a reorganization approved by the NCLT, such issuance cannot be treated as an arrangement to introduce unaccounted money, and section 56(2)(viib), being a provision brought in to curb circulation of unaccounted money, was not attracted in the facts of the case.
The ITAT further held that where valuation was carried out under Rule 11UA by registered valuers/merchant bankers, the tax authorities cannot go beyond their jurisdiction by re-evaluating the value of each share or by changing the valuation method adopted by the assessee, valuation being a complex and technical exercise. It also held that the investments having been made by a foreign owned and controlled company after due compliance with FEMA regulations, the funds could not be categorized as unaccounted money. Accordingly, both additions made under section 56(2)(viib), including the addition relating to conversion of CCPS into equity shares, were liable to be deleted.
The ITAT further held that payments made to MTH under the Master Framework Agreement were payments for services and assured margin and constituted revenue expenditure, since no capital asset or enduring benefit in the capital field accrued to the assessee; the capital expenditure was incurred in relation to hotels/properties under the relevant business model. It further held that the payment was not in the nature of interest, since it was not for servicing debt or repayment of loan but for services rendered by MTH, and therefore the basis for disallowance under section 40A(2) as excessive interest did not survive.
On the issue under section 56(2)(viib), the Division Bench comprising Vimal Kumar (Judicial Member) and S. Rifaur Rahman (Accountant Member) observed that the shares were subscribed by the parent and existing shareholders and that, after reorganization, the shareholding of the parent stood reduced from 100% to 99.6% because proportionate shares were issued to the existing shareholders of the demerged entity. The Tribunal held that the shares were issued to the existing shareholders and the holding company after approval of the scheme by the NCLT/authorities, and such issuance could not be treated as a device to introduce unaccounted money into the system.
The Tribunal further observed that section 56(2)(viib) was brought in to curb circulation of unaccounted money, whereas in the present case the company was running in consistent losses and fresh/additional capital was introduced by the parent holding company and existing shareholders because they saw potential in the company and projected future growth. It also observed that the valuation had been carried out and the value of shares obtained from RBI approved valuers, and that it is established and settled position of law that tax authorities cannot review valuation of shares done on the basis of Rule 11UA, nor can they change the valuation method adopted by the assessee, as valuation is complex and technical and the assessing authorities do not possess such expertise.
The Tribunal also noted that the investments were made by a foreign owned and controlled company after due compliance with FEMA regulations and downstream investment, and therefore such funds could not be categorized as unaccounted money.
As regards the addition on conversion of CCPS issued in earlier years into equity shares during the relevant year, the Tribunal observed that the Assessing Officer had invoked section 56(2)(viib) even for such conversion, which itself was unjustified, and that the AO could not invoke a provision which had no relevance to the present and impugned assessment year.
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On the management fee issue, the Tribunal observed that the assessee had claimed that management fees from group entities were recorded on actuals as well as estimates and that excess provisions were reversed at year-end, but these submissions had been made without proper documents and evidence. The Tribunal held that the assessee was required to explain the basis of claiming management fees from group entities for the whole year and the basis for reversal at year-end, and that vague submissions without proper justification were insufficient. It therefore considered that one more opportunity should be granted to the assessee for verification by the Assessing Officer.
On the Revenue’s challenge to deletion of disallowance regarding payment to MTH, the Tribunal examined the business model and observed that in relation to the hotel business, the assessee needed transformation and related advisory services to provide standardized OYO experience, and MTH was created to provide these services including making capital expenditure on listed hotels/properties. The Tribunal noted from the agreements that the capital investment on refurbishment and improvement to the hotel was borne by the hotel owners or by the assessee depending upon the business model, while the cost to carry out the task was guaranteed to MTH in the form of service charges and margin.
Thus, the Tribunal agreed with the CIT(A) that no capital asset was acquired or created for the assessee and that MTH offered only services. It also held that the expenditure had to be considered for what it was rather than on the basis of nomenclature used, and since it was not for servicing any debt or repayment of any loan but only payment for services rendered by MTH, it could not be treated as interest for section 40A(2) purposes.
Briefly, the principal issue in the assessee’s appeal concerned an addition of INR 3,885,51,75,255 under section 56(2)(viib) of the Income-tax Act, on account of share premium received on issuance of Compulsorily Convertible Preference Shares (CCPS) to its holding company, Oravel Stays Limited (OSL). The assessee had explained that pursuant to a scheme of arrangement approved by the NCLT, Gujarat Bench on September 26, 2019, the India hotel business was demerged from OSL into the assessee, and under the scheme shareholders of OSL were allotted shares of the assessee on a 1:1 basis. Thereafter, fresh CCPS were issued to OSL in April 2020 and November 2020 at substantial premium based on valuation reports obtained from independent valuers. The Assessing Officer rejected the DCF-based valuation, treated the premium as excessive, and made the addition under section 56(2)(viib), which was upheld by the CIT(A).
A further issue in the assessee’s appeal related to an addition of INR 9.21 crore on account of management fees. The Assessing Officer noticed that though total management fee income of about INR 57.39 crore was disclosed, a negative entry of INR 9.21 crore was passed in March 2021. The assessee contended that it followed the accrual method and that the March entry was a year-end true-up/reversal of excess accruals, but the Assessing Officer found that no proper supporting evidence had been furnished and made the addition, which was sustained by the CIT(A).
In the Revenue’s appeal, the issue was whether payments made by the assessee to Mypreferred Transformation & Hospitality Pvt Ltd. (MTH), a joint venture between OSL and SB Topaz (Cayman) Ltd. (Softbank), were capital expenditure or excessive interest liable for disallowance. The arrangement under the Master Framework Agreement provided for transformation and related advisory services, including incurring capital expenditure on hotels to meet OYO standards, and MTH was to earn a 16% assured return/cost plus margin. The Assessing Officer treated the payment as interest, compared it with a 9% bank rate, and disallowed it; alternatively, the AO viewed the payment as capital in nature. The CIT(A) deleted the disallowance, holding that what was provided by MTH was a service and not any capital asset, and that the payment was not in the nature of interest.
