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Gujarat High Court (HC) rules that gift tax provisions are not applicable to right shares
In case of Jigar Jashwantlal Shah [1] (Taxpayer), the issue before Gujarat HC was applicability of erstwhile gift tax provisions [section 56(2)(vii)(c)[2] of the Income Tax Act - ITA] on receipt of right shares by the Taxpayer based on his own original holding of shares and also of his wife and father who renounced their rights in Taxpayer’s favor.
Section 56(2)(vii)(c) of ITA (gift tax), inter alia, provided that when an individual or HUF[3] receives shares from any person or persons without consideration or for a consideration which is less than fair market value (FMV) of shares, computed in a prescribed manner, the shortfall is taxable as “Income from other sources”. However, it excludes receipts, inter alia, from relatives (as defined in the section).
In the facts of the case, the Taxpayer, being a director and shareholder in a company, subscribed to rights shares not only in respect of his original holding but also in respect of rights renounced in his favor by (a) his wife and father (relatives) and (b) third party (non-relative). The subscription was at a substantial discount to FMV of the shares. Hence, the tax authority invoked the gift tax provision in respect of all rights shares allotted to the Taxpayer relatable to his own original holding as also renunciation by relatives and non-relatives.
On appeal, the first appellate authority deleted the addition to the extent of right shares allotted proportionate to the Taxpayer’s own original holding of shares, but sustained the addition in respect of right shares on account of renunciation by relatives and non-relatives. Both the Taxpayer and tax authority filed further appeal with the Ahmedabad Tribunal.
The Tribunal gave further relief to the Taxpayer and held that gift tax provision did not apply even to rights shares allotted in respect of renunciation of rights by relatives but sustained the addition in respect of renunciation of rights by non-relatives. The Tribunal relied on various decisions[4] to hold that the gift tax provisions are not applicable to the extent right shares allotted are proportionate to the Taxpayer’s own original holding of shares and right share renounced in the favor of the Taxpayer by relative[5] .
The tax authority appealed further to the Gujarat HC in respect of relief allowed to the Taxpayer by lower appellate authorities in respect of rights shares allotted in respect of the Taxpayer’s own original shareholding and renunciation of rights by relatives.
The Gujarat HC upheld the Tribunal ruling and held that in order to apply gift tax provisions, there must be an existence of property before receiving it. The shares come into existence only when the allotment is made by the company and there is a vital difference between the issue of a share to a subscriber and purchase of a share from an existing shareholder. The first case of the issue of shares is that of creation, whereas the second case is that of “transfer”. The HC relied on the Supreme Court rulings in case of Khoday Distilleries Ltd v. CIT[6] and Shri Gopal Jalan & Co. v. Calcutta Stock Exchange Association Ltd.[7] to hold that “allotment” means appropriation out of previously unappropriated capital of a company and till such allotment the shares do not exist as such. The legislative intent was never to tax “fresh issue” or “fresh allotment” of shares by a company.”
The rights shares obtained by renunciation of right shares by relatives of taxpayer will also not attract the provisions of gift taxation since the gifts from relatives are excluded from the scope of gift taxation.