Income Tax Rule 11UA deals with Valuation of unquoted equity shares. As per Clause (b) of Sub-Rule 2 of Rule 11UA earlier merchant banker and Chartered Accountant were allowed to  do valuation of unquoted equity shares under Discounted Free Cash Flow method but vide Notification No. 23/2018 dated 24th May, 2018 it is provided that now only merchant banker can do valuation of unquoted equity shares under Discounted Free Cash Flow method and Chartered Accountants are no more allowed to do the same.

Hence, after this amendment, most of the time I have observed that many of the professionals got confused at the time of calculation of actual valuation of unquoted equity shares. Main reason behind it might be because there are many amendments in the Income Tax Rules which is used for valuation of unquoted equity shares. Therefore, today I am covering this topic today so that it will help all the professional.

When an owner of Unquoted equity shares(“Shares”) in a Company transfers the shares to any person, he is required to pay Capital Gain tax on the difference between the sale consideration received by him and the cost of acquisition of such shares (or the inflation indexed cost, wherever applicable). It is important to check if the “Sale consideration” that he receives from the buyer is at least equal to or more than the “Fair Market Value” (“FMV”) as defined under Rule 11UA of The Income Tax Rules, of the shares sought to be transferred.

The fair market value of the shares=

(i) as may be determined in accordance with such method as may be prescribed, or

(ii) 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

As per Rule 11UA of the Income-tax Rules, 1962, the FMV of unquoted shares is to be determined as under:

The fair market value of unquoted equity shares =

(A+B+C+D – L)× (PV)
PE

where,

 A= book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance-sheet as reduced by,—

  • any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and
  • any amount shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

 B = the price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

 C = fair market value of shares and securities as determined in the manner provided in this rule;

 D = the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property;

 L= book value of liabilities shown in the balance sheet, but not including the following amounts, namely:—

  • the paid-up capital in respect of equity shares;
  • the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
  • reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
  • any amount representing provision for taxation, other than amount of income-tax paid, if any, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
  • any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
  • any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

 PV= the paid up value of such equity shares;

 PE = total amount of paid up equity share capital as shown in the balance-sheet;

Note:

1. the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of which such valuation.

2. Irrespective of above valuation, the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner:

a) the fair market value of unquoted equity shares =

(A-L) x PV
PE

            where,

 A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:

    • the paid-up capital in respect of equity shares;
    • the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
    • reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
    • any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
    • any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
    • any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PE = total amount of paid up equity share capital as shown in the balance-sheet;

          PV = the paid up value of such equity shares;

b) the fair market value of the unquoted equity shares determined by a merchant banker as per the Discounted Free Cash Flow method.

Conclusion-  With effect from the 1st day of April, 2018 where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares. FMV does not imply the actual market value of the shares at which shares may be transacted between parties. It is the value of shares as determined based on book value of the assets and liabilities of the company.

The Author is a budding Tax Law Professional and may be reached @ shreetaxchambers@bsnl.in

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Disclaimer: The contents of this article are for information purposes only and does not constitute advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer to relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author / TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

(Republished with Amendments by Team Taxguru)

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2 Comments

  1. sc jain says:

    Kindly advise if

    (1) Pvt Ltd Co having 670000 equity shares of face value Rs 10 each. Paid up capital 67 Lacs. Company incorporated on 26 June 2016

    (2) 2 Promoters holding 20 % each want to exit. they hold 20 % each
    Book value of Co is Rs 12 on 30 June 2017

    As per Govt Guidelines Share value should be Rs 14 maximum.

    Since Co hold land on lease hold 66 years. It has Rs 1 crore premimium over and above book value

    what should be approximate value of share as per guideline dt 12 July 2017 ?

    If they sell shares at higher rate above guideline any problem. Say guideline value comes @ 20 per share. but they sell @ 30 per shrare ? main question is if share sold at above guidline value will it create some problem or not ?
    If some problem what ?

  2. Rakesh Kumar Singhal says:

    Whether the new rules are applicable from sale of unquoted equity shares during this year or shall be applicable on sale from next financial year

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