Section 56(2)(viib) requires a Company (issuer), not being a company in which the public are substantially interested, to issue shares at Fair Market Value (FMV). Any consideration received by such issuing Company in excess of the FMV, to the extent it exceeds the face value of such shall be liable to tax.
For the purpose of this section, FMV shall be the value:
(a) as may be determined in accordance with such method as may be prescribed; or
(b) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,
Whichever is higher
Methods prescribed under Rule 11 UA w.r.t (a) above are Book Value Method and Discounted Cash Flow Method.
Section 56 (2)(x)(c) imposes taxation in the hands of investor in case where the consideration of any property (other than immoveable property) is less that the FMV determined.
For the purpose of this section, FMV shall be the Adjusted Book Value i.e. to say all other assets and liabilities (as defined and required under Rule 11 UA), except the one’s listed below, shall be considered at Book Value :
(a) Jewellery and artistic work – price it would fetch if sold in the open market based on valuation report obtained from a registered valuer
(b) Shares and securities – market value as determined in the manner provided in Income Tax Rules
(c) Immovable property – the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty
As evident above, the method of valuation under both the Rules is different. Hence, for the same transaction, FMV shall differ from the perspective of investor [56(2)(x)(c)] and perspective of issuer [56(2)(viib)].
A Company owns an immoveable property (either land or building), the value assessable by government authority for purpose of stamp duty payment may be higher than the book value / carrying value in the books. This will lead to valuation under section 56(2)(x)(c) to be greater than book value determined under section 56(2)(viib). Thus, the dissimilarity in the prescribed method of valuation compels undue tax outflow either in the hands of investor or issuer.
Case 1:
Company A (issuer) an unlisted private Company plans to issue equity shares to Company B (investor). Company A holds total assets of Rs. 3,500,000 which also includes immoveable property at book value of Rs. 2,000,000. The value assessable by the government authority for stamp duty payment of this immoveable property is Rs. 2,800,000. The total liabilities (excluding ESC & R&S) is Rs. 3,200,000 and existing number of equity shares is 20,000 of face value 10 each. What will be the FMV at which Company may issue the proposed equity shares?
Computation of FMV for prospective issuance of unquoted ESC :
Amt in INR
| S No | Particulars | u/s 56(2)(viib) – Rule 11UA (2) | u/s 56(2)(x)(c) – Rule 11UA(1)(c)(b) |
| 1. | Total Assets (except immoveable property) | 1,500,000 | 1,500,000 |
| 2. | Add: immoveable property* | @ Book Value = 2,000,000 | @ Market Value = 2,800,000 |
| 3. | Less: liabilities | 3,200,000 | 3,200,000 |
| 4. | Total | 300,000 | 1,100,000 |
| 5. | No of equity shares | 20,000 | 20,000 |
| 6. | Value per share | 15.00 | 55.00 |
As elaborated above in illustration 1, if the Company A complies with valuation method prescribed u/s 56(2)(viib) and issues shares at FMV of Rs. 15 per share, then the investor being Company B shall be liable to pay tax since the shares will be issued at a price lower than FMV determined u/s 56(2)(x)(c).
In contrast, if Company A complies with valuation method prescribed u/s 56(2)(x)(c) and issues shares at FMV of Rs. 55 per share, then the issuer being Company A itself shall be liable to pay tax since the shares will be issued at a price higher than FMV determined u/s 56(2)(viib).
As elucidated in illustration 1, the intent of introducing section 56 under the Act stands defeated due to this contradiction as the intent was never to bring the genuine transactions under the taxation ambit of section 56.
Conclusion – Considering the above, in my view, Companies may consider taking resort to the second option available under section 56(2)(viib) wherein Company may use any other method of valuation to the satisfaction of Assessing Officer [in this case being the method prescribed under section 56(2)(x)(c)] – Refer case law Lalithaa Jewellary Mart (P.) Ltd. v. ACIT (178 ITD 503) (Chennai Trib.). Though this does not resolve completely the apprehensions as acceptance of this method is at the discretion and satisfaction of the assessing officer. A concrete resolution would be a notification or press release by the Department itself elucidating a redressal to this contradiction.
Relevant reference link:
Section 56 of Income Tax – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx
Rule 11 UA -https://www.incometaxindia.gov.in/_layouts/15/dit/Pages/viewer.aspx?path=https://www.incometaxindia.gov.in/Rules/Income-Tax%20Rules/103120000000007268.htm&IsDlg=0
Case law reference link:
https://indiankanoon.org/doc/136003418/
Author Bio
Why not resort to disc. cash flow method… In this way the value for 56(2)(viib) can never be less then 56(2)(x) ?