The Finance Act, 2017 has introduced two important sections in the Income tax Act, 1961, with the intent of curbing perceived tax abuse: section 56(2)(x) and section 50CA. While the existing anti-abuse section, i.e., section 56(2)(vii) was applicable only in case of individuals, HUF, firms and unlisted companies; section 56(2) (x) has been incorporated to widen its scope and cover “any person” receiving certain “property” without or for inadequate consideration. Thus, from a receiver’s perspective, under section 56(2)(x), the receipt of money or specified property by any person for without or for inadequate consideration shall be subject to tax. On the other hand, from the seller’s perspective, section 50CA provides that where consideration for transfer of shares of a company (other than a quoted share) is less than the Fair Market Value (FMV) determined as per the prescribed Rules, the value as determined shall be deemed to be the full value of consideration for computing income under the head “capital gains.”
On 12 July, 2017, the CBDT issued its final notification to amend existing Rule 11UA and introduce Rule 11UAA, which provides guidelines for computing the FMV of unquoted shares of a company for the purpose of sections 56(2)(x) and 50CA, respectively.
While the earlier rule required that the unquoted equity shares are to be valued based on the book values of the assets and liabilities, the amended rule requires the valuation to be carried out at fair values for underlying assets, as listed below.
| Asset | Valuation basis pre- amendment | Valuation basis post- amendment |
| Jewellery and artistic work | Book Value | Market price, i.e., price if sold in the open market, as determined by a registered valuer |
| Shares and securities | Book Value | • Quoted equity shares – FMV on a recognised stock exchange
• Unquoted equity shares – Value as computed under the amended Rule 11UA • Other shares and securities – Price if sold in the open market, as determined by a merchant banker or an accountant |
| Immovable property | Book Value | Market value, i.e., value assessed or assessable for stamp duty purposes |
Thus, the valuation methodology has migrated from the concept of book value to fair value. The valuation methodology is likely to trigger a quantum leap in the valuation of unquoted shares, resulting in higher tax inflows for the Revenue. While the given rules are self-explanatory for certain assets, there are ambiguous areas and issues, some of which are listed below.
- The amended rules do not deal with scenarios such as multi-tier structures and cross-holdings. In a multi-tier structure, if the ultimate company’s shares are to be valued, the unquoted shares of each company in the chain below need to be valued too, which would be tedious and beset with practical difficulties. In addition, in case of cross-holding of shares, the rule creates a circular effect and possibly double counting in the value of equity shares.
- The evergreen question of whether to reduce preference capital remains unanswered by the new rule as well. The old rules and new rules both require reducing liabilities from the value of assets. So, should preference share capital be treated as debt liability or share capital? A strict interpretation of the rules suggests that preference share capital is required to be reduced; however, typically, preference capital is not in the nature of liability and is not reduced.
- The values to be adopted are as per the balance sheet on the date of receipt/ transfer of property. For all practical purposes, an audited balance sheet on the date of transfer/ receipt is unlikely to be readily available. Further, whether an audited balance sheet is required for every/ multi tranche transfer that may take place in a financial year is an unanswered question. In many cases, the holdings may not be significant. In such cases, obtaining necessary information relevant to the date of the transaction itself seems impossible.
- In an outbound holding structure, if the shares of an Indian company or the immediate first level overseas subsidiary/ JV company are transferred, one may need to consider the application of provisions of section 50CA and 56(2)(x) read with the amended rules.
Even on transactions at arm’s length, on the basis of a negotiated price and considering internationally accepted methods of valuation, the FMV computation adds a layer of cumbersome checking to ensure the transaction is not falling foul of the rules. Thus, considering the significant practical difficulties, some additional contemplation by the authorities on the above aspects with subsequent clarifications, would establish a robust computational mechanism for valuing unquoted shares.
Views expressed are personal and the article includes inputs from Vishal Yeole, Associate Director, M&A Tax, PwC India and Pratik Jain, Associate, M&A Tax, PwC India.
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Respected Sir,
let me know if according Audited Balance Sheet 31.03.2017 the FMV is Rs. 10.13, and if equity shares are sold on 05.04.2017 at Face value of Rs. 10/- each Shares are about 10 lakhs and amount is Rs. one crore.whether will be any tax,please guide?