Devesh Cinemas vs ITO – Unexplained Share Premium and Section 56(2)(viib) Dispute – ITA No. 6184/DEL/2019

Case Summary: Devesh Cinemas vs ITO, Ward-2(1), Faridabad

Case Number: ITA 6184/DEL/2019

Appellant: Devesh Cinemas, Faridabad

Respondent: ITO, Ward-2(1), Faridabad

Assessment Year: 2015-16

Date of Filing: 22nd July 2019

Order Type: Final Tribunal Order

Date of Pronouncement: 12th July 2022

The case involving Devesh Cinemas and the Income Tax Officer (ITO), Ward-2(1), Faridabad, centers on the addition made by the Assessing Officer (AO) under Section 68 of the Income Tax Act, 1961, regarding unexplained share premium and share capital. The case also involves the enhancement of income under Section 56(2)(viib) by the Commissioner of Income Tax (Appeals) [CIT(A)]. The primary issue in this case revolves around the legitimacy of the share premium received by Devesh Cinemas and whether it was justifiable under the prevailing tax laws.

Background of the Case

Devesh Cinemas, a cinema business based in Faridabad, was assessed for the financial year 2014-15, corresponding to the assessment year 2015-16. During this period, the company issued shares at a premium, which caught the attention of the tax authorities. The AO, upon scrutinizing the financial statements, raised concerns about the legitimacy of the share premium, suspecting that the company might be inflating its share capital without adequate justification. Consequently, the AO added Rs. 38,00,000/- as unexplained cash credits under Section 68 of the Income Tax Act.

The CIT(A), upon reviewing the case, not only upheld the AO’s addition but also invoked Section 56(2)(viib) of the Income Tax Act, further enhancing the income by Rs. 66,00,000/-. This section deals with the taxability of share premiums received by companies in excess of the fair market value of the shares issued. The CIT(A) concluded that the valuation method adopted by Devesh Cinemas was flawed and that the share premium charged by the company was unjustified.

Key Issues Raised

The key issues in this case include:

• The legitimacy of the share premium received by Devesh Cinemas and whether it was justified under Section 68 of the Income Tax Act.
• The applicability of Section 56(2)(viib) in taxing the share premium, based on the valuation method used by the company.
• The procedural lapses in the issuance of a valid show-cause notice by the CIT(A) before enhancing the income of Devesh Cinemas.

Tribunal Proceedings and Findings

The Income Tax Appellate Tribunal (ITAT) heard the case on 18th May 2022 and pronounced its final order on 12th July 2022. During the proceedings, the counsel for Devesh Cinemas argued that the company had adhered to all necessary procedures and provided adequate documentation to substantiate the share premium received. The counsel emphasized that the identity, creditworthiness, and genuineness of the transactions had been established through the submission of certificates of incorporation, audited financial statements, income tax returns, and bank statements of the investor companies.

Moreover, the counsel pointed out that the CIT(A) had erred in rejecting the valuation method adopted by Devesh Cinemas without providing a valid reason. The valuation was conducted using the Discounted Cash Flow (DCF) method, which is one of the prescribed methods under Rule 11UA of the Income Tax Rules, 1962. The counsel argued that the CIT(A) did not have the authority to question the commercial wisdom of the company or to reject the DCF method without proper justification.

On the other hand, the Departmental Representative (DR) supported the CIT(A)’s decision, arguing that the share premium charged by Devesh Cinemas was excessive and not supported by the company’s financials. The DR also contended that the CIT(A) had acted within the bounds of the law by enhancing the income under Section 56(2)(viib).

Tribunal’s Decision

The ITAT, after reviewing the submissions and the evidence on record, ruled in favor of Devesh Cinemas. The Tribunal held that the company had duly discharged its onus of proving the identity, creditworthiness, and genuineness of the transactions as required under Section 68. The Tribunal noted that the AO and CIT(A) had dismissed the documentary evidence submitted by Devesh Cinemas without conducting any further inquiry, which was not justified.

Regarding the application of Section 56(2)(viib), the ITAT found that the CIT(A) had wrongly rejected the DCF method without providing any valid reason. The Tribunal emphasized that when a company follows one of the prescribed methods for share valuation, the tax authorities cannot arbitrarily reject it without substantial evidence or legal basis. The Tribunal also highlighted that the CIT(A) had failed to provide a mandatory opportunity for Devesh Cinemas to explain or defend its position before enhancing the income, which was a serious procedural lapse.

Consequently, the ITAT directed the AO to delete the addition of Rs. 38,00,000/- made under Section 68 and set aside the enhancement of Rs. 66,00,000/- made under Section 56(2)(viib) by the CIT(A). The Tribunal concluded that Devesh Cinemas had sufficiently justified the share premium received and that the valuation method adopted by the company was in accordance with the law.

Conclusion

The ITAT’s decision in this case underscores the importance of adhering to prescribed valuation methods under the Income Tax Rules and the necessity for tax authorities to provide valid reasons when rejecting such valuations. The ruling also highlights the procedural safeguards that must be observed by tax authorities when enhancing a taxpayer’s income, particularly the requirement to issue a valid show-cause notice. This case serves as a crucial reference for future disputes involving share premiums and the application of Section 56(2)(viib).

Order Pronounced: The appeal of the assessee, Devesh Cinemas, is allowed, and the additions made by the AO and CIT(A) are set aside.

Devesh Cinemas vs ITO – Unexplained Share Premium and Section 56(2)(viib) Dispute – ITA No. 6184/DEL/2019