Central Board of Direct Taxes (‘CBDT’) has released draft rules relating to valuation methodology of unquoted equity share. The draft rules are in furtherance to the new sections as introduced by Finance Act, 2017 i.e. section 50CA and 56(2)(x). These sections are introduced to ensure that the sale consideration for transfer of unquoted equity shares are not understated.
Prior to section 50CA, income chargeable under the head ‘Capital Gains’ was computed by taking into account the amount of full value of consideration received or accrued on the transfer of capital asset. In order to ensure that the full value of consideration is not understated, Income-tax Act, 1961 (‘Act’) also contained provisions for deeming of full value of consideration in certain cases such as deeming of stamp duty value as full value of consideration for transfer of immovable property in certain cases. However, no such provisions were available to cover movable property like unquoted equity shares.
In order to curb the same, section 50CA has been introduced to tax the cases where the consideration for transfer of share of a company (other than quoted share) is less than the Fair Market Value (‘FMV’) of such share determined in accordance with the prescribed manner, the FMV shall be deemed to be full value of consideration for the purposes of computing income under the head ‘Capital Gains’.
Further, the recipient of such shares will also be subject to tax under section 56(2)(x) in case the difference between the FMV and the sale consideration exceeds rupees fifty thousand.
Both the above sections have been introduced as the anti-abusive measures by the Government in this Finance Act. By way of enactment of these two sections, the Government tries to pluck the probable loss, occurring on account of understatement of consideration for transfer of shares. However, potential double taxation may also arise.
The potential double taxation may be understood will the help of the following example:
A acquired 10,000 shares of a private limited company at INR 50 per share. The shares were sold by A to B at INR 80 per share. FMV of the shares on the date of transfer was INR 100 per share. The impact of section 50CA and section 56(2)(x) would be as follows:
Capital gain in the hands of A
|Particulars||Old Position||New Position|
|Cost of acquisition||(5,00,000)||(5,00,000)|
Income from other sources in the hands of B
|Income from other sources||2,00,000||2,00,000|
From the above example, it can be seen that the difference between the FMV and the actual sale consideration is taxable in the hands of both transferor as well as transferee i.e. Rs. 2,00,000 is taxable in the hands of B as well A (through deeming fiction).
Earlier if Jewellery, artistic work, shares, securities, and immovable property are held as asset by a company whose shares are unquoted, for the purpose of valuation of such shares, the book value of the assets as per balance sheet was considered. However, the draft Rules propose to consider the FMV of such assets.
As per Rule 11UA in case of valuation for the purpose of Section 56 and Section 50CA, following method of valuation shall be applied:
Fair market value of unquoted equity shares = (A+B+C+D-L) X (PV)/(PE)
Under the existing provisions, where jewellery, artistic work, shares, securities, and immovable property are held as asset by the unlisted company, for the valuation of such shares the book value of the assets as per the Balance Sheet are considered. However, the draft rules propose to consider the FMV of such assets.
As per Rule 11UA of the Income-tax Rules, 1961, the FMV of unquoted equity share for the purpose of section 50CA and 56(2) shall be calculated by applying the following formula:
Fair Market Value of unquoted equity share = (A+B+C+D-L)*(PV)/(PE)
|A||All assets other than jewellery, artistic work, shares, securities and immovable property||Book Value of such assets|
|B||Jewellery and artistic work||The price it would fetch if sold in the open market on the basis of valuation report obtained from a registered valuer.|
|C||Share and securities||Fair market value of shares and securities as determined in the manner provided Rule 11UA|
|D||Immovable Property||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||Liabilities||Book value of liabilities, however, excluding certain items like paid up capital on equity shares, amount set apart for payment of dividend on both preference and equity shares, reserves and surplus, other than set apart for depreciation, provisions and contingent liabilities.|
PE = total amount of paid up equity share capital as shown in the Balance-Sheet.
PV = the paid up value of such equity shares.
The impact of these sections are required to be analysed for every transaction from seller and buyer perspective. There may be a possibility of litigation on account of double taxation of the same item in two different hands as discussed in the above paragraphs. Accordingly, more clarification is required in the provision to reduce litigation and provide certainty on its scope.