Background
In a recent ruling, the Mumbai Income-tax Appellate Tribunal (“the Tribunal”), in the case of Lupin Investments Private Limited1 (“the Company”), examined the applicability of Section 56(2)(viia) of the Income Tax Act, 1961 (“IT Act”) to the buyback of shares by a closely held company. The Tribunal analysed whether the extinguishment of equity shares through buyback without the shares becoming property in the hands of the company could trigger taxability under Section 56(2)(viia), or whether such transactions fall outside its scope due to the failure of key statutory tests.
The judgment reiterates the interpretative boundaries of Section 56(2)(viia), affirms the exclusion of buyback transactions from its ambit, and underscores the importance of legal substance over form in determining tax liability under the IT Act. While the ruling addresses multiple tax issues, this note is confined to the aspects concerning buyback taxation and procedural irregularities in the assessment process.
Facts of the case
- On January 18, 2016, the Company bought back and extinguished 1,90,097 unlisted equity shares at Rs 10 per share, totalling to Rs 19,00,970.
- The AO applied Section 56(2)(viia), computing the fair market value (FMV) of shares at Rs 1,836 per share using Rule 11UA, resulting in an addition of Rs 34.71 crore.
- Lupin Investments Pvt. Ltd. is the successor to Zyma Laboratories Ltd., which was amalgamated into Lupin effective October 1, 2016. The merger was duly communicated to the Assessing Officer (AO) during the assessment proceedings.
- The AO initially issued an unsigned assessment order dated December 27, 2018 in the name of the non-existent Zyma Laboratories Ltd. A second signed order was issued on the same date and with the same order number, but in the name of Lupin Investments Pvt. Ltd., the successor entity.
Key Issues
- Applicability of Section 56(2)(viia) on buyback of own shares.
- Validity of framing assessment in the name of a non-existent (amalgamating) company.
Key Takeaways
- Inapplicability of Section 56(2)(viia) to buy-back transactions
- Section 56(2)(viia) applies only when a firm or company receives shares of another company as property for inadequate consideration. Own shares bought back and extinguished by the Company cannot be said to have become the “property” of the company nor are they “shares of any other company.”
- The ITAT relied on the co-ordinate bench’s interpretation2, specifically highlighting that two cumulative conditions must be satisfied for Section 56(2)(viia) to apply:
- The shares received must constitute “property” in the hands of the recipient.
- Such shares must be of “another company”, not the recipient’s own.
- In the instant case, the Company purchased its own shares under a buyback scheme and the same has been extinguished by reducing the capital. Hence, the tests of “becoming property” and “shares of any other company” fail in this case. Therefore, Section 56(2)(viia) does not apply.
- Validity of Assessment Order
- The initial order was issued in the name of Zyma Laboratories Ltd., a non-existent entity post-amalgamation. This order was unsigned and deemed non-est in law.
- However, a second, valid signed order was issued in the name of Lupin Investments Pvt. Ltd., the successor company.
- Upholding the second order as legally sustainable, the Tribunal dismissed the challenge.
Conclusion
The Tribunal’s decision clarified key tax principles holding that buyback of own shares isn’t covered by Section 56(2)(viia). It also invalidated an unsigned assessment order issued to a non-existent entity and upheld the subsequently issued valid order. The judgment underscores the importance of procedural precision and contextual interpretation in tax assessments.