Income Tax

Issue of Shares at Premium under Income Tax Act


Share Premium is a capital receipt. Start-ups are issuing shares at a premium. In recent times, the Government of India has been proposing various incentives to simplify the start-up regime, encourage entrepreneurship and give an overall boost to the startup space.

As per provisions of law companies and accounting and disclosures by companies, share premium or security premium is considered a capital receipt and shall be shown in Reserves and Surplus as an item on the liabilities side of balance sheet. The Security premium can be used only in a limited manner permitted by the law. The permissible use of such reserves generally results in an increase in share capital or reduction of some specified liabilities on capital account. The securities premium is to strengthen the financial structure rather keep the strength of financial structure undiluted. The amount standing insecurities premium is either converted into capital or reduces liabilities.

Share premium is generally considered as a capital receipt under Income-tax Act, 1961:

Share issued at a premium by closely held companies subject to some exceptions are covered under Section 56 (vii(b)). This is not applicable to a company which is listed on a recognized stock exchange and some other companies, which are also considered as a company in which public is substantially interested. In case of issue of shares at a premium by listed companies, share premium shall not be considered as income. In case of unlisted companies premium can be considered as income in case the price charged at the time of issue of share is more than face value and is also higher than fair market value. In such case, any excess of issue price above the fair market value is considered as income of issuing price.

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In case a company issues shares at face value however market value is lower than face value, the difference between prices charged that is issue price and fair market value will not be considered as income.

Let’s understand with an example:

The issue at face value:

Fair market value of a share of Rs.10/- is now Rs.3/- due to an erosion of capital by past losses. Issue price is Rs. 10 which is face value. In this case excess of issue price above the fair market value that is Rs.7/- per share will not be considered income because an issue is at face value of Rs.10/-.

The issue at a premium:

Fair market value of a share of Rs.10/- is now Rs.3/- due to an erosion of capital by past losses.Issue price per share of Rs. 10/- is Rs. 15/- that is at a premium of Rs.5/- per share. In this case excess of issue price above the fair market value that is Rs.12/- per share will be considered as income of a company.

In this case, two conditions are applicable:

Issue price in excess of face value and also in excess of fair market value are satisfied. In this case, although Rs.10/-are received and credited towards share capital and Rs.5/- per share towards share premium, still Rs.12/- per share will be considered as income although premium was only Rs.10/- per share.

This shows some anomaly in provisions.

Hence, as per provisions of tax on income share premium is principally regarded as a capital receipt. However, an effort has been made by the government to bring into tax net share premium received by closely held companies. This is due to suspicion that in form of share capital and premium, company.

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Regarding the issue of shares at par and at a premium:

Issue price of share including share premium is a subject matter of financial planning and negotiation between the company and its shareholders.

Shares are issued at a premium with a view to supporting capital base keeping share capital low so that servicing of share capital (by paying dividend and issue of free shares/s bonus shares) is easy and better in future.

One important aspect of share premium about dividend can be illustrated with an example of shares, the market price of share and dividend yield.

Provisions of S.68:

As per provisions of section 68, any unexplained credit found in books of account of assets can be considered as income, if the assets cannot satisfactorily explain the nature and source of receipt of sum represented by credit. Therefore, share capital and share premium both can also be considered as income, if the assessee is unable to establish identity and existence of shareholders who contributed share capital and premium. In case the shareholder has not disclosed or accounted for his investment, then he can be taxed by way of including undisclosed/ unaccounted for investments in his income.

However, in hands of company share capital may not generally be taxable, because shareholders are publicly recognized as a shareholder of the company and such shares are transferable by the shareholder.

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