Share Application Money Not Allotted in India

Legal Framework and Implications of Share Application Money Not Allotted in India

Introduction

The process of raising capital through the issuance of shares is fundamental to corporate finance in India. When a company invites subscriptions for its shares, it receives money from applicants, known as share application money. However, situations often arise where the company is unable to allot shares against the application money received, either partially or in full. This non-allotment can occur due to various reasons, such as oversubscription, failure to meet minimum subscription requirements, or withdrawal of the issue. The legal treatment of such share application money not allotted is governed by a complex interplay of provisions under the Companies Act, securities regulations, and income tax laws. This article provides a comprehensive analysis of the legal obligations of companies, the rights of applicants, and the potential financial and tax implications arising from share application money not allotted, drawing upon statutory provisions and judicial pronouncements in India.

Background: The Process of Share Issuance and Application Money

A company may issue shares to the public (public offer) or to a select group of persons (private placement)[1]. In either case, prospective investors apply for shares and remit the application money as specified in the offer document (e.g., prospectus or private placement offer letter). This money is typically required to be kept in a separate bank account[2]. Allotment is the formal act by the company of appropriating a certain number of shares to an applicant. If shares are not allotted, the application money, or the excess thereof, must be dealt with in accordance with the law.

The Supreme Court in Raymond Synthetics Ltd. And Others v. Union Of India And Others[2] clarified that money credited to a separate bank account for share applications is held by the company for and on behalf of the subscribers in a fiduciary capacity until allotment. Such amounts do not form part of the general assets of the company, and the relationship is that of ‘bailors and bailee’ rather than creditors and debtor.

Legal Framework for Refund of Share Application Money Not Allotted

The Companies Act, 2013 (and its predecessor, the Companies Act, 1956) lays down specific timelines and procedures for the allotment of shares and the refund of application money in case of non-allotment.

Provisions under the Companies Act, 2013

For public offers, Section 39(3) of the Companies Act, 2013, mandates that if the stated minimum amount has not been subscribed and the sum payable on application is not received within thirty days from the date of issue of the prospectus, or such other period as may be specified by SEBI, the amount received shall be returned within such time and manner as may be prescribed. Failure to repay within the prescribed period renders the company and its officers in default liable to repay that money with interest at the rate of fifteen per cent per annum.

In the context of private placements, Section 42(6) of the Companies Act, 2013, stipulates that a company making an offer or invitation under this section shall allot its securities within sixty days from the date of receipt of the application money. If the company is not able to allot the securities within that period, it shall repay the application money to the subscribers within fifteen days from the expiry of sixty days. Failure to repay the application money within the aforesaid period will make the company liable to repay that money with interest at the rate of twelve per cent per annum from the expiry of the sixtieth day. This provision has been noted by the National Company Law Appellate Tribunal (NCLAT) in cases like Uniexcel Developers Pvt. Ltd. v. Uniexcel Ltd.[3] and MURLIDHAR VINCOM PRIVATE LIMITED v. M/S Skoda (India) Pvt. Ltd.[4], where unrefunded share application money, coupled with the interest liability, was considered in the context of "financial debt" under the Insolvency and Bankruptcy Code, 2016 (IBC).

The Supreme Court in Raymond Synthetics Ltd. And Others v. Union Of India And Others[2], interpreting the erstwhile Section 73 of the Companies Act, 1956 (related to allotment of shares to be dealt in on stock exchange), held that the liability to repay excess application money arises at the end of 10 weeks from the closure of subscription lists, and interest becomes payable if repayment is delayed beyond eight days from this liability date. This underscores the legislative intent to ensure prompt refund.

Withdrawal of Application

An applicant may, in certain circumstances, withdraw their application before allotment. The Delhi High Court in The Securities & Exchange Board Of India v. A.P.L Industries Ltd. & Ors.[5] noted the contention that a prospectus is an invitation to offer, and an applicant can withdraw their offer prior to its acceptance, which culminates into a contract only upon allotment of shares.

Consequences of Non-Refund or Delayed Refund

Failure to refund share application money within the stipulated time can lead to several consequences for the company.

Interest Liability

As discussed, both Section 39(3) and Section 42(6) of the Companies Act, 2013, prescribe specific rates of interest payable by the company for delays in refunding share application money.

Treatment as "Deposit"

Under Rule 2(1)(c)(vii) of the Companies (Acceptance of Deposits) Rules, 2014, any amount received and held pursuant to an offer made in accordance with the provisions of the Act for subscription to any securities, including share application money or advance towards allotment of securities, is not considered a deposit, provided that if the securities for which application money or advance for such securities was received are not allotted within sixty days from the date of receipt of the application money or advance, and such application money or advance is not refunded to the subscribers within fifteen days from the date of completion of sixty days, such amount shall be treated as a deposit under these rules. The Income Tax Appellate Tribunal (ITAT) in M/s Cepham Dairy Development Limitted, Chandigarh v. Pr.CIT-1, Chandigarh[6] observed that once share application money is not returned within the stipulated timeframe, it partakes the character of a deposit. Similarly, in Cit v. Object Frontier Software Pvt. Ltd.[7], the ITAT considered that share application money held for one to three years could be treated as deposits, though noting a contrasting High Court view in another case.

Conversion to Unsecured Loan

Companies sometimes attempt to reclassify unrefunded share application money as unsecured loans. However, this is subject to legal scrutiny. The Delhi High Court in DALMIA CONSUMER CARE PVT. LTD. v. PAHARPUR 3P[8] clarified that reflecting unutilized share application amounts as unsecured loans does not automatically validate the claim. The company must establish that the amounts were genuinely received for share allotment, and proper corporate authorizations (e.g., board resolutions, consent from depositors for interest-free loans) are necessary. The Company Judge would examine the permissibility of such treatment and the potential imposition of interest liability.

Limitation for Claiming Refund

Applicants seeking a refund must be mindful of the limitation period. The Punjab & Haryana High Court in Sham Lal Gupta v. M/S. Hemco Industries (P) Limited[9] considered Article 70 of the Limitation Act, 1963, for a claim related to refund of money advanced, where the period of limitation is computed from the date of refusal after demand.

Insolvency Implications (IBC)

As highlighted in Uniexcel Developers[3] and MURLIDHAR VINCOM[4], share application money not allotted within the statutory period under Section 42(6) of the Companies Act, 2013, and consequently becoming refundable with interest, can be categorized as "financial debt" under Section 5(8) of the IBC. This allows the applicant to initiate corporate insolvency resolution process against the defaulting company.

Taxation Aspects: Section 68 of the Income Tax Act, 1961

Share application money, particularly if it remains unallotted and unexplained for extended periods, can attract scrutiny from income tax authorities under Section 68 of the Income Tax Act, 1961, which deals with unexplained cash credits.

Onus of Proof and Genuineness

The Supreme Court in Principal Commissioner Of Income Tax (Central) - 1 v. Nra Iron & Steel Pvt. Ltd.[10] reinforced that the assessee bears the onus to prove the identity of the investors, the genuineness of the transaction, and the creditworthiness of the investors. Failure to discharge this onus can lead to the amount being treated as undisclosed income. The Delhi High Court in Commissioner Of Income-Tax, N. Delhi v. Sophia Finance Ltd.[11] affirmed the Income Tax Officer's (ITO) authority to investigate the legitimacy of share capital, including the existence of shareholders, and if found fictitious, the receipts could be classified as undisclosed income under Section 68. This principle was further elaborated in Commissioner Of Income Tax v. Divine Leasing & Finance Ltd.[12], which detailed the respective burdens on the assessee and the Revenue.

However, if the assessee provides adequate documentation, the additions may not be sustained. In Cit v. Independent Media Pvt. Ltd.[13], additions made by the Assessing Officer (AO) treating share application money as undisclosed income were deleted by the CIT (Appeals) upon the assessee filing documents like share application forms, board resolutions, bank statements, PAN details, etc. Similarly, in Cit v. Gangeshwari Metal Pvt. Ltd.[14], the assessee furnished extensive documentation, yet the AO made additions, highlighting the rigorous scrutiny involved. The Delhi High Court in Commissioner Of Income Tax v. Victor Electodes Ltd[15] observed that if share application money is received via account payee cheques through normal banking channels from identifiable sources, the department could proceed against individual shareholders if they are found bogus, rather than making additions in the company's hands, provided the company has furnished necessary details.

A distinction may be drawn between allotted share capital and share application money pending allotment. In Commissioner Of Income-Tax v. Gold Leaf Capital Corporation Ltd.[16], the Delhi High Court noted that the ratio of CIT v. Steller Investment Ltd. (that no addition can be made in the hands of the company for share capital from bogus shareholders, but action can be taken against shareholders) may not apply to share application money against which shares have not been allotted, and the onus under Section 68 for such pending money must be discharged by the assessee.

AO's Duty of Inquiry

While the initial onus is on the assessee, the AO also has a duty to conduct proper inquiries. In M/s Cepham Dairy[6], the ITAT noted the Pr. CIT's finding that the AO had failed to adequately verify outstanding share application money, not raising queries about names, addresses, reasons for non-allotment, or confirmations.

Disallowance of Related Expenses

If borrowed funds are used to provide share application money that remains pending allotment, and this investment is for earning potentially exempt dividend income, interest on such borrowed funds may be disallowed under Section 14A of the Income Tax Act. The ITAT in Aban Investments Pvt. Limited v. Deputy Commissioner Of Income Tax[17] (and its counterpart appeal[18]) dealt with this issue, holding that whether shares were allotted or not was not relevant if the funds were advanced for allotment with the purpose of earning dividend income.

Furthermore, if a company pays interest on share application money that is subsequently refunded (due to non-allotment), the deductibility of such interest expenditure (whether revenue or capital) can be a contentious issue, as discussed in S.R. Thorat Milk Products Pvt. Ltd. v. Cit[19].

Taxability of Share Premium

If shares are eventually allotted against pending application money at a premium, Section 56(2)(viib) of the Income Tax Act, 1961, may come into play if the consideration received for issue of shares exceeds the fair market value of the shares. The ITAT in The ITO v. M/s Sardar Patel Hospital & Research Centre LTD[20] discussed a scenario where shares were allotted at a premium in a subsequent year against application money received earlier, and the assessee argued against the applicability of Section 56(2)(viib) for the year of receipt of application money.

Specific Scenarios and Judicial Interpretations

Courts and tribunals have addressed various specific situations involving share application money not allotted.

In Ruby General Hospital Limited And Others v. Dr. Kamal Kumar Dutta And Another[21], the Company Law Board (CLB), while dealing with disputes of oppression and mismanagement, directed that share application money with the company should not be used for further allotment of shares pending High Court proceedings, aiming to maintain status quo.

The meaning of "allotment" itself was discussed by the Supreme Court in Sri Gopal Jalan And Co. v. Calcutta Stock Exchange Association Ltd.[22] in the context of filing returns of allotment under Section 75(1) of the Companies Act, 1956, particularly concerning re-allotment of forfeited shares. While not directly on non-allotment of initial application money, it clarifies the nature of allotment as an appropriation of shares.

Conclusion

The legal regime governing share application money not allotted in India imposes strict obligations on companies to ensure timely allotment or refund. The Companies Act, 2013, provides clear timelines and mandates interest payments for delays, treating such funds with a fiduciary character. Non-compliance can lead to the money being treated as a "deposit," attracting further regulatory requirements, or even as "financial debt" under the IBC, exposing the company to insolvency proceedings. From a taxation perspective, unexplained or unrefunded share application money can be assessed as undisclosed income under Section 68 of the Income Tax Act, 1961, if the assessee company fails to discharge the onus of proving the identity and creditworthiness of the applicants and the genuineness of the transactions. Comprehensive documentation and adherence to statutory procedures are paramount for companies to mitigate these risks. For applicants, understanding their rights to refund and interest, and the available legal recourse, including limitation periods, is crucial. The judiciary has consistently emphasized transparency and accountability, reinforcing the protective measures for investors and the integrity of the capital market.

References