Deemed consideration for transfer of unquoted shares under section 50CA

Every year, tax professionals eagerly look forward to the budget to identify new provisions to learn (or unlearn). We see many tax amendments introduced by the Revenue Department to counter the judicial decisions. However, this continuous tinkering of the tax laws to counter the judicial precedents may change the rules of the game favouring the revenue; however, such changes are not helpful for the business community as they bring in uncertainty on how transactions will be taxed.

One such provision introduced this year is the new section, 50CA, which states that where the consideration on transfer of a capital asset, being shares of a company (other than quoted share), is less than the fair market value (FMV), then the FMV shall be deemed to be the full value of consideration for computing due taxes. This will be effective from Assessment Year 2018–19 (effective Financial Year 2017–18).

Before deep diving into this new provision, it is critical to understand the concept of income in the context of capital gain. The courts have held for time immemorial that while determining the tax on capital gain, what can be taxed is only the consideration the assesse has actually received and not what he ought to have received or what he may have perceived to have received. This interpretation of section 48 has withstood the test of time and has served as the core for computing capital gains on many transactions.

However, the Revenue Department now wants to change this time-tested principle, and, in fact, it has slowly been introducing specific provisions over the years to counter this. Sections 50C and 50D immediately come to mind. The government may contend that these are specific anti-avoidance measures enacted to curb tax evasion. However, while the government’s reasoning may be lauded, specific anti-avoidance measures can sometimes have bad tax consequences for arms-length transactions. For instance, in a bearish trend in real estate, because of section 50C, the tax officer can tax transactions at the value adopted for registration purposes, even though it is lower than the agreed transaction value.

The new section 50CA is also aimed in this direction and targets shares of companies (other than quoted shares) that are transferred for lesser than the FMV. The rules for determining the FMV for this section is awaited. Hence, currently, it is ambiguous as to what constitutes the FMV of unquoted shares. While there are many internationally accepted methods of valuation, one is unsure which one to apply for the current section while determining FMV. However, assessees may get some indication on the valuation of shares from Rule 11UA, which is prescribed for identifying value under section 56(2). Needless to say, in the absence of clear rules, the jury is still out on this matter.

On the other hand, for transactions undertaken at less than the FMV, the transferee may be additionally taxed under the new section 56(2)(x) on the ground that he/ she has understated the purchase consideration. Thus, the above mechanism may lead to dual taxation of the same consideration, that is, the difference between the FMV and the declared consideration in the hands of the two taxpayers, the transferor and transferee.

Further, there is no provision for reference to a valuation officer in case of any dispute as provided for in similar sections, such as sections 43CA and 50C. Hence, this might lead to several tax litigations without resolution unless a similar clause is inserted or the rules are made unambiguous.

Another important aspect is that the section only applies to transfer of shares other than the quoted shares. The term “Quoted Shares” has been defined as “the shares quoted on any recognized stock exchange with regularity from time to time, where the quotation of such share is based on the current transaction made in the ordinary course of business.”

 Hence, for a share to fall within said definition, it should be regularly traded on the stock exchange and its quotation should be based on a recent normal transaction. The term has been defined narrowly, and hence infrequently traded quoted shares may not qualify for the definition and be subjected to tax under this section. Thus, even for transactions of listed shares, one has to ensure that these shares fall within this definition so as not to be taxed differently. For instance, strategic transfers of listed shares undertaken at a mutually agreed price, which is different from the last traded price, may be taxed differently than the agreed price.

Another point to be noted in this new section is that while the seller pays capital gains tax on the FMV, the FMV may not be available as cost of acquisition for the buyer. This may be damaging, especially in case of intra-group share transfers wherein one entity pays capital gains tax on the FMV without the corresponding cost base being available to the buyer entity.

In summary, this new provision with its ambiguities may end up taxing several genuine transactions at different values than the consideration actually received by the transferor. With the General Anti Avoidance Rule (GAAR) being effective from this year, the Finance Ministry has empowered the tax officers with enough power to target tax evasion cases. Hence, one hopes the government will opt for stability in the tax regime and not introduce specific anti-avoidance measures, thereby constantly changing the tax landscape.

Further update on 11.05.2017

CBDT releases draft valuation rules for Section 50CA and 56(2)(x)

The CBDT has released the draft rules for determining the FMV of unquoted shares for the purposes of newly inserted section 50CA and 56(2)(x) on May 05, 2017. The draft rule proposes to amend Rule 11UA and also proposes to insert new rule 11UAA for valuation in relation to section 50CA, which is in line with the amended Rule 11UA. The proposed rule brings parity in the valuation method for direct acquisition of assets and indirect acquisition of the same as part of acquisition of unquoted equity share. Earlier, the FMV of unquoted shares was based on essentially the book value; however, the proposed draft rule seeks to value the company based on the company’s underlying assets including immovable assets, investments and other assets like jewellery. This revised rule may impact asset (immovable) heavy entities, group holding entities etc.

Views expressed are personal to the author. Article includes inputs from Janardhan Rao Belpu – Director –M&A Tax, PwC India and Kavitha Shankar – Assistant Manager, M&A Tax, PwC India