Proportionate Rights Shares Allotment Not Taxable Merely Due to Price Difference: Bombay High Court

On Thursday, 22 October, the Bombay High Court held that the difference between the subscription price and fair market value of proportionately allotted rights shares cannot, by itself, be taxed under Section 56(2)(x) of the Income-tax Act when the shareholder's percentage holding remains unchanged and no disproportionate benefit is identified.

A Division Bench comprising Justices B. P. Colabawalla and Farhan P. Dubash allowed Grasim Industries Limited's petition challenging reassessment proceedings over an alleged taxable benefit of Rs. 329 crore arising from its subscription to Vodafone Idea Limited's rights shares. They held:

“We accordingly hold that, in the facts of this case, Section 56(2)(x) cannot be invoked merely to tax the difference between the subscription price and the fair market value of the rights equity shares proportionately allotted to the Petitioner. Our finding is confined to the allotment before us, in which the Petitioner's percentage shareholding is stated to have remained unchanged and no disproportionate benefit has been identified. The basis for reassessment is therefore unsustainable.”

Grasim subscribed to Vodafone Idea's rights shares at Rs. 12.50 per share. The Income Tax Department valued the shares at Rs. 13.925 per share and sought to tax the difference under Section 56(2)(x) of the Income-tax Act, which covers specified receipts of property without consideration or for inadequate consideration. Grasim challenged the reassessment.

It argued that Vodafone Idea offered the shares to existing shareholders in proportion to their holdings and that its percentage ownership remained unchanged. It also contended that the Department initiated the proceedings beyond the statutory limitation period.

The Court observed that a rights allotment must be examined in the context of the shareholder's existing interest in the company, as issuing additional shares also affects the value of existing shares. It held that the difference between the subscription price and fair market value did not, by itself, establish an equivalent economic benefit. The Department had identified no disproportionate benefit to Grasim and relied solely on the price difference.

Further, the Bench rejected the Department's argument that it could examine taxability at a later stage of reassessment. Since the nature of the transaction was undisputed, the Department could not initiate proceedings on an unsustainable statutory basis and defer the issue for determination at a subsequent stage.

Separately, it held that the reassessment proceedings had not been validly initiated within the statutory limitation period.

Accordingly, the High Court quashed the show-cause notice, the order permitting reassessment and the consequential reassessment notice, while leaving Grasim's other grounds of challenge open.

Appearances: Senior Advocate J. D. Mistri, with Madhur Agrawal and Punit Shah, instructed by Atul K. Jasani, for Grasim; Akhileshwar Sharma for the respondents.