Transfer of Shares – Unlisted Companies
The principal statute governing the administration of limited as well as private limited companies was reformed & reshaped before few years to be called as the Companies Act, 2013 (hereinafter referred to as “the 2013 Act” for short). The Capital of a Company (whether limited or private limited) is divided into Shares. Each share forms a unit of Ownership and is offered for sale so as to raise the capital required for doing business in the Company.
In terms of Section 44 of the 2013 Act, the shares or debentures or other interest of any member in a Company shall be a “movable property”, transferable (from one person to another) in the manner provided by the Articles of Association of the Company. Previously, the securities were transferred only through physical mode, however, after the beginning of depository system in the country in the year 1996-97, the shares and securities are transferred in dematerialized form, to a large extent.
According to the Company Law, shares of a Public Limited Company are freely transferable whereas a Private Limited Company is required to restrict the right to transfer its shares by its Articles of Association (Section 2 (68) of the 2013 Act). Hence, in view of the importance of transfer of shares, which is as equivalent as to transfer of ownership, provisions for regulation of their transfer have been enacted in Section 56 to 59 of Companies Act, 2013and the Companies (Share Capital & Debentures) Rules 2014.
Method for Transfer of Shares under Companies Act, 2013:
The inclusive provisions covering the procedure for transfer of shares are spared under the Articles of Association of the Company. In general, below mentioned procedure is followed by a private limited company to give effect to the transfer of shares. Here, transferor is the person desiring to sell the shares (Seller) and transferee is the person who desires to buy those shares (Buyer).
1. First of all, the Transferor is required to give a written Notice in writing to transfer his shares to the Company in which he/she holds shares.
2. On receipt of the said Notice, the Company in turn, notifies about the offer to the other members along with the price at which such shares would be available to them for purchase. More often, this right of members is eventually called as a “Right of Pre – Emption”.
3. Determination of the price at which the transfer shall be held. (Being an important part of the whole transfer process, the same is dealt with in thorough detail at the later part of this write up).
4. Written intimation sent by the Company should contain the timeline within which the buying members should revert. If the existing members did not reply in the given timeline, it is deemed to be taken as unacceptance of offer and shares are then offered to the outsider.
5. The Company will then have no other option, except accepting the transfer of shares to the outsiders who in turn may have or use this as an undue advantage as in the private limited company, sometimes entire shareholding is owned by a family or group of friends or any other such private group.
6. Pursuant to Section 56 of the 2013 Act, on final acceptance of offer for purchase of shares by the transferee; the transferor or the transferee has to deliver the instrument of transfer in Form SH 4 as specified in Rule 11 of the Companies (Share Capital & Debentures) Rules, 2014 along with the Share Certificate or Letter of Allotment (if the certificate is not in existence) within 60 days from the date of execution.
7. Form SH 4 should be duly filled, stamped, signed and certified by/on behalf of the transferor and by/on behalf of the transferee containing all the detailed as required therein. The signatures of both the parties are also required to be personally witnessed.
8. To be called valid, it should also bear stamps in accordance with Indian Stamp Act, 1899 read with the Notification of Ministry of Finance, Department of Revenue dtd. 24th January, 2004. The rate of duty is 25 paise for every Rs. 100 (0.25%) or part thereof of the “Value of Shares”. These stamps are called as “share transfer fees” & the same are available with Stamp Vendors or at the Treasury Office of respective district/town. These stamps are then required to be cancelled so that it cannot be misused. The methodology of cancellation is given in respective state stamp laws.
9. On receipt of Form SH 4, the Board of Directors considers and verifies the same, mostly, in a duly convened Meeting and if all the documents are in order, the transfer of shares is registered by passing a Resolution.
In case of a Public Limited Company, Section 58 of the 2013 Act provides that the shares or debentures and any interest therein shall be freely transferable. Hence, the process of making an offer by invoking the Right of Pre – Emption or any other such rights to the existing members and applying the Company for approval of registration for transfer of shares, does not come in performance unless stipulated in the Articles of Association of the Company.
Determination of the Value of Share as on the date of transfer:
The principles governing the determination of the value of unlisted shares and securities are laid down under Section 56 2 (x) of the Income-tax Act, 1961 read with Rule 11UA of the Income-tax Rules, 1962. The Finance Act, 2017 inserted clause (x) in Section 56 of the Act to widen the scope of taxability and restrain the practice of receiving shares without consideration or for inadequate consideration by all types of persons (previously it was limited to individuals and HUFs). Clause (x) applies to all kinds of properties defined therein which also includes shares and securities.
Besides, presently, the income chargeable under the head Capital Gains is computed by taking into account the amount of full value of consideration received/accrued on transfer of capital asset. In order to curb foul practices resulting in the avoidance of capital gain tax on transfer of shares, a new section 50CA is inserted in the Income-tax Act, 1961 through the Finance Act, 2017 which provides that where consideration for transfer of the unquoted equity share of a Company is less than the Fair Market Value (FMV) of such a share, the FMV shall be deemed to be the full value of consideration for the purposes of computing income under the head “Capital Gains”. The section further provides that FMV should be determined in the manner as prescribed and laid down under the Rules framed thereunder.
Before moving forward, it is important to understand what is “Fair Market Value”?
Fair Market Value is defined under Section 2 (22B) of the Income-Act, 1961. It is confined in relation to a capital asset. Meaning thereby;
The transfer of quoted shares (meaning -the shares quoted on any recognized stock exchange with regularity from time to time, where the quotation of such share is based on current transaction made in the ordinary course of business) is done through trading that takes place at the transaction value in the secondary market of the stock exchanges which is said to be its Fair Market Value. However, if such securities are transacted through a medium other the recognized stock exchange, then the basis for determination of FMV would be the lowest price quoted as on the said date.
The transfer of unquoted shares is however subject to determination of a “Fair Market Value (FMV)” calculated in accordance with the method (formula) as prescribed in Rule 11U & 11UA of the Income-tax Rules, 1962. More or less, the value comes near to the Book Value. The said valuation has to be supported, reported and certified by a Category I – Merchant Banker OR a Chartered Accountant who should be a Fellow Member of the Institute of Chartered Accountants of India & not a Statutory Auditor of the Company.
Let us understand the above referred provisions with an assuming example:
Mr. A is holding 2000 Equity Shares in ABC Limited as on 2nd September, 2017. He (Mr. A) further transfers those shares to Mr. B for a consideration of Rs. 15,00,000/- on 6th September, 2017. Further, Mr. A acquired those shares on 17th August, 2016 at the Cost of Rs. 10,00,000/-. As on the date of transfer, the Fair Market Value comes to Rs. 17,50,000/-.
In the hands of Mr. A, Capital Gain shall be calculated as follows:
|Full Value of Consideration||Rs. 17,50,000/- (FMV)|
|Less: Cost of Acquisition||Rs. 10,00,000/-|
|Short Term Capital Gain||Rs. 7,50,000/-|
In the hands of Mr. B, it is sustained that the shares whose FMV is Rs. 17,50,000/-, are purchased for inadequate consideration of Rs. 2,50,000/- (being the difference between FMV and the Cost of Acquisition). This, Rs. 2.5 Lacs is taxable in the hands of Mr. B.
Conclusion: Section 50CA of the IT Act, taxes the difference between the FMV and the consideration received for transfer of shares as Capital Gains in the hands of “Transferor”, whereas Section 56 (2) (x) taxes the difference in the hands of the “Transferee” of such shares. The aforesaid computational mechanism may lead to taxation of the same amount of consideration in hands of two tax payers i. e. the transferor and transferee. However, it is pertinent to obtain the Fair Market Value and then execute the transfer process so as to avoid unnecessary tax obligations.
For further assistance, contact CS Nikhil Gajjar, N. V. Gajjar & Associates, Company Secretaries @ firstname.lastname@example.org