[Opinion] Taxability of Right Issue Allotments Under Section 56(2)(vii)(c) | Judicial View and Analysis

M. Poorna Chander Rao, Adv. M.L. Niharika and U. Prabhakar – [2025] 180 taxmann.com 659 (Article)

1. Introduction

The issuance of shares through a Right Issue—where existing shareholders are offered the option to subscribe to additional shares in proportion to their existing holdings—is a well-established mechanism for raising capital. However, its tax implications under Section 56(2)(vii)(c) (now Section 56(2)(x)) of the Income Tax Act, 1961 (“the Act”)—which seeks to tax the receipt of property for inadequate consideration—have been the subject of considerable debate.

The relevant part of the section is reproduced below:

” 56. Income from other sources.

(2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely:

(vii) where an individual or a Hindu undivided family receives, in any previous year, from any person or persons ………

(c) any property, other than immovable property:

i. without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggre¬gate fair market value of such property.

ii. for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration.”

The central question is whether the allotment of shares through a right issue constitutes a “receipt of property” from another person or merely represents the creation of a new asset by the issuing company. In this regard let’s us look at how the Judicial Forums have viewed this rights issue till date.

2. Judicial Perspective – Higher Court Rulings on Right Issue Allotments

2.1 Supreme Court in Khoday Distilleries Ltd. v. CIT [2009] 176 Taxman 142/[2008] 307 ITR 312 (SC)

The Hon’ble Supreme Court, while interpreting similar provisions under the Gift Tax Act, 1958, held that the allotment of right shares represents the creation of shares out of unissued capital, not their transfer. Consequently, no taxable event arises upon such allotment. The Court observed:

“There is a vital difference between the creation and transfer of shares. The term ‘allotment of shares’ indicates the creation of shares by appropriation out of unappropriated share capital to a particular person… The issue of a share to a subscriber is creation, whereas the purchase of a share from an existing shareholder is transfer… Accordingly, such allotment does not constitute a transfer and therefore falls outside the ambit of section 4(1)(a).”

This landmark judgment clearly distinguished “allotment” from “transfer” in corporate and tax law contexts.

2.2 Andhra Pradesh High Court in Spectra Shares & Scrips (P) Ltd. v. CIT [2013] 36 taxmann.com 348/219 Taxman 61 (Mag.)/354 ITR 35 (A.P.)

The Hon’ble Andhra Pradesh High Court elaborated that capital-raising measures such as bonus and rights issues are structured exercises governed by the Companies Act, forming part of the legitimate corporate process. These transactions cannot be equated with arrangements intended for tax avoidance in the absence of explicit statutory provisions.

2.3 Gujarat High Court in Pr. CIT v. Jigar Jashwantlal Shah [2023] 154 taxmann.com 568/460 ITR 628 (Guj.)

In this significant ruling, the Gujarat High Court reaffirmed that shares allotted through a right issue amount to creation of property and not a transfer thereof. The Court clarified that Section 56(2)(vii) targets abusive transfers of existing property, not bona fide capital-raising activities by companies. Accordingly, right issue allotments do not constitute the “receipt of property” contemplated under this provision.

“In the facts of the case, the shares had come into existence only when the allottment is made by the company as right shares cannot be said to be ‘received from any person’. The shares which have been allotted to the assessee were not ‘received from any person’ which is the fundamental requirement for invoking section 56(2)(vii)(c). In other words, the property must pre-exist for application of section 56(2)(vii)(c), which is clear from the intention of the legislature.”

Collectively, these judicial pronouncements establish a coherent principle:

The allotment of shares through a right issue does not amount to the “receipt” of property, and hence Section 56(2)(vii)(c) or Section 56(2)(x) cannot be invoked.

If no property exists at the time of the transaction—as in the creation of new shares—there can be no “receipt” of such property, and consequently, no occasion for valuation under Fair Market Value (FMV) principles.

This issue was recently examined by the Income Tax Appellate Tribunal (ITAT), Hyderabad Bench, offering valuable judicial insight.

3. ITAT Hyderabad Decision – Ushasree Bandaru v. Dy. CIT [IT Appeal No. 529 (Hyd.) of 2024, dated 21-5-2025]and Satyasree Kamineni v. DCIT (ITA Nos. 528)

3.1 Facts of the Case

In these connected appeals, the assessees, individual shareholders in two closely held companies, subscribed to additional shares offered through a right issue.

The Principal Commissioner of Income Tax (PCIT) while reviewing u/s 263 the reassessment proceedings in the above case has come across the rights issue and concluded in his proceedings that the assessees were liable to pay tax u/s 56(2)(vii)(c) for the difference between the FMV determined under Rule 11UA of Income Tax Rules, 1962 and the price at which the company offered the said right shares to its shareholders and accordingly directed the AO to modify the Assessment order.

3.2 Tribunal’s Findings

Upon appeal, the Hon’ble ITAT – Hyderabad set aside the revisionary order. Drawing support from the decisions in Jigar Jashwantlal Shah (supra), Khoday Distilleries (supra) and Spectra Shares & Scrips (supra), the Tribunal held:

• The allotment of right shares represents a creation of property by the company and does not amount to a receipt of shares under Section 56(2)(vii)(c).
• Anti-avoidance provisions such as Section 56(2)(vii)(c) must be interpreted strictly and not applied to legitimate corporate actions.

Click Here To Read The Full Article