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Tax Insights from India Tax & Regulatory Services
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Share application money not share capital, interest thereon a revenue expenditure
June 8, 2016
In brief
The Pune Income-tax Appellate Tribunal (the Tribunal) recently held that share application money received from shareholders pending allotment could not be characterised as or equated with share capital. Accordingly, the payment of interest on such share application money that had been utilised for business purposes was a revenue expenditure.
In detail
Background
The taxpayer1 was a closely held company (the Company), engaged in the business of processing of milk and manufacturing of milk products. During assessment year (AY) 2004-05 to AY 2009-10, the Company had received share application money from existing shareholders from time to time.
In the financial year (FY) 2003-04 (relevant to AY 2004-05), the Company decided that since the shares could not be allotted within a reasonable time frame, the money had to be refunded along with interest @ 12% per annum. Accordingly, as and when the share application money pending allotment was refunded to the shareholders, interest @ 12% per annum was also paid after deducting appropriate taxes at source. The
1 TS-304-ITAT-2016(Pune-Tribunal)
taxpayer claimed the interest paid to the shareholders on the share application money as a revenue expense.
The Tax Officer (TO) disallowed the interest paid on share application money, stating that such interest was allowable neither under section 36(1)(iii) nor under section 37(1) of the Income-tax Act, 1961 (the Act). The TO held that the following ingredients of borrowing by the taxpayer were not present when interest was paid on receipts in the nature of share application money:
a positive act of lending by one and expense thereof by the other;
an obligation of refund or repayment thereof.
The TO, relying on the decision of the Supreme Court (SC) in the case of Punjab State Industrial Development Corporation Ltd2 and Brooke
2 Punjab State Industrial Development Corporation Ltd. v. CIT [1997] 225 ITR 792 (SC)
Bond India Ltd.3, held that the expenditure on account of interest paid on share application money was not revenue but a capital expenditure, and was not allowable under section 37(1) of the Act. Further, in the absence of any act of borrowing, the conditions prescribed under section 36(1)(iii) of the Act were not fulfilled. The TO disallowed the interest paid on share application money in the taxpayer’s hands.
Aggrieved by the TO’s order, the taxpayer filed an appeal before the Commissioner of Income-tax (Appeal) [CIT(A)] and argued that the share application money was used for business purposes, and that the same could not be characterised as share capital until actual allotment. The CIT(A) endorsed the TO’s finding.
3 Brooke Bond India Ltd. v. CIT [1997]s 140 CTR 598 (SC)
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Aggrieved by the CIT(A)’s order, the taxpayer filed an appeal before the Tribunal in respect of the TO’s disallowance of interest paid on share application money. In addition, the taxpayer also raised legal objections of improper compliance with section 147 of the Act in respect of the AYs 2004-05, 2007-08 and 2008-09, stating that the taxpayer’s objections raised in the course of hearings against the reasons recorded under section 148(2) of the Act for the aforesaid AYs had not been disposed of.
Taxpayer’s contentions
The taxpayer contended that till the shares were actually allotted, the share application money was in the nature of ordinary fund similar to borrowed funds. Further, the taxpayer argued that a review of the final accounts and cash flow statement revealed that the entire share application money had been deployed for business purposes. Therefore, interest incurred on the share application money pending allotment was a revenue expense. The obligation to refund or repay principal amount received was always inherent until such amount was actually converted into share capital by allotment.
The taxpayer relied on the decision of the co-ordinate bench of the Tribunal in the case of Rohit Exhaust Systems Pvt. Ltd.4 that I turn relied on the Tribunal decision in the case of Western India Forgings Ltd.5 wherein, on similar facts, the Tribunal had ruled in the taxpayer’s favour by holding that the interest paid on share application money used for business purposes was allowable on the principle of commercial expediency. The taxpayer further contended that the disallowances under sections 36(1)(iii) and 37(1) of the Act were unwarranted.
Revenue’s contentions
The TO’s main contentions were that there was no act of borrowing 4 ACIT v. Rohit Exhaust Systems Pvt. Ltd ITA No. 686/PN/2011 and ITA No. 687/PN/2011
in respect of the share application money, and that the act of receiving or soliciting share application money was not akin to the act of borrowing.
One of the CIT(A)’s findings was that what needed to be examined first was whether facts on record showed that seeking the share application money and its subsequent use were necessitated by a legitimate need to raise equity for business purposes, and whether the taxpayer intended to allot shares. Further, during the years under consideration, there were allotments of shares out of such share application money. Thus, the taxpayer did not borrow money for business purposes, but intended to allot shares, thereby giving it the colour of equity and not borrowed capital.
The Revenue distinguished the facts in this case from those in Western India Forgings Ltd.5, where the share application money had been received from various members of the public and for public issue, but due to recession and high cost of servicing equity, the Board of directors decided to refund the amount collected along with interest. In the instant case, share application money had been received from Directors and their family members, and shares had been allotted in at least two of the AYs under appeal. Thus, the money that had been received with the intention of allotment of shares could not subsequently acquire the colour of borrowed funds, even though it might have been used for business purposes.
Tribunal’s ruling
The Tribunal first disposed of the legal objection raised by the taxpayer in terms of improper compliance with section 147 of the Act, noting that the TO was restrained from complying with
5 Western India Forgings Ltd., ITA No. 419/PN/2002
the judicial direction since there was inordinate delay on the taxpayer’s part. The Tribunal also distinguished the taxpayer’s case from the SC decision in GKN Driveshafts India Ltd.6, wherein the TO was directed to dispose off the objections by passing a speaking order. In this case, the Tribunal held that the objections were not filed within a reasonable time by the taxpayer, thus leaving barely a few days for the TO to discharge his statutory responsibilities. Thus, the legal objections were unsustainable.
While deciding on the issue of interest paid on share application money, the Tribunal, relying on the decision in Rohit Exhaust Systems Pvt. Ltd.4, held that the share application money per se could not be characterised as and equated with share capital. It agreed with the taxpayer’s contention regarding the obligation to return money being implicit in the event of non-allotment of shares, and the argument that share application money was not held towards share capital, and if it had been utilised for business purposes, interest paid thereon until allotment was a revenue expenditure.
The takeaways
From the above ruling, the following interesting points emerge:
share application money cannot be characterised as share capital until allotment and is in the nature of debt owed
the interest paid on share application money used as working capital for business purposes has been held as revenue in nature
This judgment is for a period under the old Companies Act, 1956, applicable to a closely held
6 G.K.N. Driveshafts India Ltd. v. ITO, [2003] 259 ITR 19 (SC)
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company. Reasons for delay in allotment of shares have not been discussed, nor has the issue of the arm’s length nature of the transaction been analysed. It will be interesting to see how the ratio of this case can be applied in the future under the new Companies
Act, 2013 and the prescribed rules for allotment of shares and refund of share application money.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tax & Regulatory Services – Direct Tax
Gautam Mehra, Mumbai +91-22 6689 1154 [email protected]
Rahul Garg, Gurgaon +91-124 330 6515 [email protected]
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For private circulation only This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwCPL, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of PwCPL, this publication may not be quoted in whole or in part or otherwise referred to in any documents. © 2016 PricewaterhouseCoopers Private Limited. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity.
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