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SECTION 37 – VALUATION OF SHARES IN PRIVATE COMPANY

1543. Valuation of equity shares in a private limited company where alienation of shares is restricted – Guidelines therefor

CLARIFICATION 1

1. Section 37 deals with valuation of shares in a private company where alienation of shares is restricted. The section reads as under:

“Where the articles of association of a private company contain restrictive provisions as to the alienation of shares, the value of the shares, if not ascertainable by reference to the value of the total assets of the company, shall be estimated to be what they would fetch if they could be sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, but the fact that a special buyer would for his own special reasons give a higher price than the price in the open market shall be disregarded.”

The Board in their letters dated 3-5-1965 and 5-7-1965 issued from F. No. 25A/3/65-ED [printed here as Clarifications 2 & 3] clarified the scope of this section. Briefly, the clarification runs as follows :

Section 37, which governs the mode of valuation of shares in a private limited company whose articles of association contain restrictive provisions as to the alienation of its shares, contemplates :

(a)  firstly, it should be seen whether the value of shares is ascertainable by reference to the value of the total assets of the company; and

(b)  if it is not so ascertainable, then it shall be estimated to be what it would fetch if sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, disregarding any special price that might be paid by a special buyer.

If clause (a) applies the value of shares should be determined by break-up method taking the market value of the assets of the company and not the book value, if that does not happen to be their market value. If clause (b) applies then the Assessing Officer need not necessarily adopt the break-up method but may also adopt some other method of valuation based on the yield or profits, etc.

2. These instructions appeared to have been impliedly modified by Circular No. 1-D/ED of 1968 which extended the method of valuation prescribed by the Wealth-tax Rules to valuation of shares for purposes of the Estate Duty Act. On a reference from the Revenue Audit, the Board, after consultation with the Ministry of Law on the scope of section 37, issued Instruction No. 771 dated 29-10-1974 directing that contents of Circular No. 1-D/ED of 1968, dated 26-3-1968 will not apply to valuation of shares covered by section 37 but that the valuation of such shares will be governed by the Board’s earlier letters dated 3-5-1965 and 5-7-1965 issued from F. No. 25A/3/65-ED [Clarifications 2 and 3]. Thus, the expression “value of the total assets of the company” in section 37 would mean market value of the assets and not the book value of the assets; further, the expression “total assets of the company” would include goodwill also, whether or not shown as such in the balance sheet.

3. An allied issue is valuation of shares in a case where two or more private companies hold shares of each other  and valuation of such shares to be made by the break-up method. The Board are of the view that in such cases the value of the shares can be determined by framing and solving simple equations.

Instruction : No. 835 [F. No. 313/88/74-ED], dated 24-5-1975 [Source : 178th Report (1983-84) of the Public Accounts Committee, pp. 54-55].

CLARIFICATION 2

1. Attention is invited to the instructions on the valuation of shares, not quoted on the stock exchange, detailed in paragraph 1(c) of the Board’s Circular No. 3-WT of 1957, dated 28-9-1957. According to these instructions, the value of such shares is to be determined on the basis of the value of assets, i.e., break-up value. The method of valuation of shares in the cases of investment companies for the purposes of Wealth-tax Act has been explained in Board’s Circular No. 6-D(WT) of 1960, dated 8-8-1960.

1 2. Under the Estate Duty Act, section 37 governs the mode of valuation of shares in a private limited company where alienation is restricted. The Board desire that uniform practice should be followed by the officers on the estate duty side in this matter. In this connection, the Board would like to point out that for purposes of valuation of unquoted shares under section 37, the value to be taken into consideration should be based on the break-up value by taking the market value of the assets of the company and not the book value if that does not happen to be their market value.

Instruction : No. 25A/3/65-ED, dated 3-5-1965 [Source : 178th Report (1983-84) of the PAC].

CLARIFICATION 3

1. Section 37, which governs the mode of valuation of shares in a private limited company whose articles of association contain restrictive provisions as to the alienation of its shares contemplates :

(a)  firstly, it should be seen whether the value of shares is ascertainable by reference to the value of the total assets of the company; and

(b)  if it is not so ascertainable, then it shall be estimated to be what it would fetch if sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, disregarding any special price that might be paid by a special buyer.

2. The instructions issued by the Board in their circular letter referred to in para 1 above were only with regard to the first part contemplated by section 37. They do not and were not intended to restrict the application of the second part of section 37 for which purpose it would be open to the Assessing Officer to adopt some other method of valuation based on the yield of profits, etc.

Instruction : No. 25A/3/65-ED, dated 5-7-1965.

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