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Promoters may be taxed on notional gains in new firms
June, 08th 2007

Promoters that get shares at par in a new company they float may have to pay tax on the notional gains they make, based on a fair market valuation done by the income tax department.
 
A proposal to this effect is being considered by the Central Board of Direct Taxes (CBDT).
 
The department has raised such tax demands in some cases Mukesh Ambanis shareholding in Reliance Industries being a prominent one. It now wants legislative backing for its actions through an amendment to the Income Tax Act, to avoid delays on account of appeals by companies.
 
The income tax department has made this recommendation on the ground that some companies with large market capitalisation have given shares to their promoters at par in a new company they have floated.
 
When such shares come up for assessment, a premium should be attached due to the inherent intrinsic value of the project, according to the IT department.
 
The recommendation is based on the assessment of Reliance Infocomm share issued at par (Re 1 each) to Reliance Industriess Chairman Mukesh Ambani and promoters of a company called Kaizen Commercial Private Ltd.
 
Kaizen Commercial had offered an initial capital of Rs 3 crore to Reliance Infocomm. In return, the company was offered 30 million shares at par.
 
The department, which had raised a demand of Rs 45 crore on Kaizen Commercial for the assessment year 2001-02, has approached the tribunal since the income tax (appeals) had rejected its claim.
 
The department had attached a premium to these shares based on Section 2(24)(iv) of the Income-tax Act, 1961, which provides for profits and gains of business profession based on the value of any benefit or perquisite arising from the business, which may or may not get converted into money.
 
Income tax officials are of the view that notional gains are also benefits arising from the business connection of promoters/directors.
 
The department had earlier questioned Mukesh Ambanis contention that the benefit accruing from the transfer of 500 million shares of Reliance Infocomm to him in March 2004 was not income.
 
It asked him to pay tax on a deemed income of Rs 2,653 crore for the 2004-5 assessment year. Ambani, who had returned the shares, has since appealed against this tax demand.
 
The departments notice had said that going by Reliance Infocomms valuation at Rs 53.71 per share in November 2002, the 500 million shares received by Ambani were worth Rs 2,685 crore.
 
Ambani had provided a loan of Rs 50 crore to Reliance Infocomm, but the department said nobody would transfer shares worth Rs 2,685 crore against a loan of Rs 50 crore.
 
The tax authorities felt that an income gain of Rs 2,635 crore had accrued to Ambani (subtracting Rs 50 crore from Rs 2,685 crore) according to the provisions of Section 2(24)(iv) of the Income-Tax Act, 1961.

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