QUESTION: I am a director of a closely held private company which had recently acquired shares in a company by investing Rs.25 lakhs. In view of my role in acquiring these shares and my service to the company as a director, the directors at the board meeting had sold these shares to me at Rs.1 lakh. However, my auditor says that this will not be accepted by the Assessing Officer, since the shares are sold hardly four months after acquisition with no fact to justify such a steep fall in price and the difference will be taxed in the hands of the company or on me or both. But he is not able to point out any provision in the statute which requires an assessee to sell its assets only at market value. Sec. 40A(2), I am advised by a well-informed friend, would only bring to tax a concession in a payment by way of expenditure to a related party. I am also advised that, since sale was also prior to October 1, 2009, Sec. 56(2)(vii), which brings to tax any concession derived in a purchase at less than the fair market value, will also not apply. At any rate, this new provision applies only to purchaser and could not have any application for the company. What is your view of the matter?
ANSWER: Where a concessional price is a glaring one, it is certainly a matter for enquiry. Merely because the transaction is approved by the board of the company, it need not be treated as binding on the Assessing Officer. Any colourable device may well be ignored as decided in McDowell and Co. v. CTO (1985) 154 ITR 148 (SC). Where a similar benefit was granted to a relation of a director, the High Court in CIT v. S. Kannan (1994) 210 ITR 585 (Kar) following this decision of the Supreme Court held that the Company Law is “bereft of family feeling, if it is coldly approached”. One may also add, that the conduct of the directors in approving a transaction at a price conspicuously lower than the market value is open to question and may well be invalid if challenged, because the consideration is illusory. It is because, a director holds the position of a fiduciary and is, therefore, expected to discharge his duties as a trustee for the shareholders at large and not for any particular person including a shareholder. The fact that it is a family company makes no difference, so that the transaction could be dismissed as non-genuine. In Bajaj Auto Ltd. v. N.K. Firodia (1971) 41 Comp. Cas. 1 , it was held that the directors are expected to use their discretion for the benefit of the company and towards every shareholder and not for the interest of any particular shareholder. In V.S. Ramasamy Iyar v. Brahmayya & Co. (1966) 1 Comp. LJ 107 (Mad), it was pointed out that, the directors could be liable for misuse of their power expected to be exercised as trustees for the properties of the company and that any money lost for the company may be recovered even from the estate of such director after his death.
In a recent decision, the Punjab and Haryana High Court in CIT v. Rockman Cycle Industries Private Limited (2010) 326 ITR 291 (P&H) , it has pointed out, that where a transaction is imprudent and abnormal as was found in a transaction with a sister company, it was rightly treated by the Assessing Officer as non-genuine.
It is in this context, a note of caution was apparently sounded by the auditor, that a tax liability may be inferred for the company. Since past service is one of the reasons for concessional sale, the concession may be taxable as remuneration or perquisite of his office as director.
If it is so offered for tax in director's hands, there may be a case, where the sale may be accepted at face value as a benefit intended for the past service rendered by a director-employee. Any other argument in the query as advised by the well-meaning friend may well land both for the company and the directors in liability.
