Gift Tax – Background
The provisions of section 56(2)(vii) were introduced as a counter-evasion mechanism to prevent the laundering of unaccounted income under the pretext of a gift, particularly after abolition of the Gift Tax Act.
Under the existing provisions of section 56(2)(vii), if an individual or an HUF received any sum of money or any property in kind without consideration or for an inadequate consideration being in excess of the prescribed limit of INR50,000, the same was chargeable to income-tax in the hands of recipient under the head “income from other sources”.
However, receipts from relatives or on the occasion of marriage or under a will were outside the scope of this provision. The existing definition of property for the purposes of section 56(2)(vii) included immovable property being land or building or both, shares and securities, jewelry, archeological collection, drawings, paintings, sculpture or any work of art.
These anti-abuse provisions were however applicable only if an individual or an HUF was the recipient. Therefore, the transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value did not attract the anti-abuse provision. Thus, leaving behind adequate room for abuse of the provisions.
Introduction of 56(2)(viia)
To prevent the practice of transferring unlisted shares at prices much below their fair market value, it was proposed to amend section 56 and to also include within its ambit transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where the recipient is a firm or a company (not being a company in which public are substantially interested). And hence vide Finance Act, 2010, section 56(2)(viia) was made applicable on receipt of shares of a company not being a company in which the public are substantially interested in cases where such transfer takes place with no or inadequate consideration on or after the 1st day of June, 2010, where such shares have been received by a firm or a company not being a company in which the public are substantially interested. However, the transactions undertaken for business reorganization, amalgamation and demerger, etc. were specifically excluded out of the scope of this section.
Substitution of old provisions
With a view to widen the scope of the existing gift tax provisions, the above said sections were consolidated under a new gift taxation provision (section 56(2)(x)) of the Income Tax Law vide Finance Bill, 2017. Thus, section 56(2)(viia) ceased to operate w.e.f. 1 April 2017. The amended gift taxation provisions are not only wider in its scope and but also apply to all categories of taxpayers uniformly, including in relation to receipt of shares of specified company as aforesaid.
First Circular: Short lived relief for the taxpayers
The CBDT by Circular No. 10/2018 dated 31 December 2018 (First Circular) clarified that clause (viia) was inserted in section 56(2) of the Act as an anti-abuse provision to prevent the practice of transferring shares of a specified company for no or inadequate consideration. It was also stated in the circular that the intention of the legislature was never to apply these provisions of said clause (viia) to the fresh issuance of shares by the specified company.
The circular further clarified that keeping in view the legislative intent to apply anti-abuse provision contained in section 56(2)(viia) to transfer of shares for no or inadequate consideration, section 56(2)(viia) of the Act shall apply in cases where a specified company or firm receives the shares of the specified company through transfer for no or inadequate consideration.
Hence, the provisions of section 56(2)(viia) of the Act shall not be applicable in cases of receipt of shares by the specified company or firm as a result of fresh issuance of shares including by way of issue of bonus shares, rights shares and preference shares or transactions of similar nature by the specified company.
Second circular: Immediate withdrawal by CBDT
Post issuance of the First Circular, the CBDT noted that the interpretation of the term “receive” used under the erstwhile gift tax provision is pending for adjudication before the higher judicial forums. Further, stakeholders approached the CBDT to seek clarification whether views expressed in First Circular will also apply to current gift tax provision. Therefore, the CBDT was of the view that the matter required examination afresh so that a comprehensive circular on the matter can be issued. Hence, vide Circular No. 2/ 2019 issued on the 4 January 2019 (Second Circular), the CBDT withdrew First Circular clarifying that the First Circular shall be considered to have never been issued. The CBDT further clarified that a comprehensive circular on the subject shall be issued in due course.
Third Circular: Clarification by CBDT to ignore views expressed in First Circular
The CBDT issued Circular No. 3/ 2019 issued on 21 January 2019 (Third Circular) clarifying the issue. It was stated that keeping in view the plain reading as well as the legislative intent of erstwhile and current gift tax provisions being anti-abuse in nature, the view taken in the First Circular would not be a correct approach as it could be subject to abuse and would be contrary to the express provisions and legislative intent of erstwhile and current gift tax provision. The Third Circular further states that any view expressed by the CBDT in First Circular shall be considered to have never been expressed.
Though the withdrawal of First Circular, which was in line with Supreme Court rulings in case of Khoday Distillers Ltd vs CIT (307 ITR 312), will add to existing tax uncertainty, it is worth mentioning that bonafide taxpayers with transactions of bonus issue or preferential allotment at fair commercial value which may be lesser than fair value as per gift tax provisions and in line with other statutory provisions of corporate law/ exchange control regulations can still be defended by relying on the legislative intent. It may still be open for taxpayers to contend that a circular which is prejudicial and not in line with correct legal position should not be binding.
The author of this blog is Ritika Loganey Gupta, Tax Partner, EY India
The blog is co-authored by Ankur Singla, Tax Director, EY India