Valuation of an asset is essential for taking any commercial decision whether purchase, sale or transfer. In addition to valuation done for commercial decisions, income tax requires separate valuation under Rule 11 UA of income tax rules 1962 for collecting income tax. While taking any decision, it is very important to evaluate valuation as per income tax and its impact on the proposed transaction. This article is an attempt to identify and evaluate various provisions relating to the valuation requirements as per income tax, 1961 and its impact.
In the present corporate era, Valuation is key driver in any corporate decision-making process especially in M&A, Business Restructuring, Issue or Transfer of shares or any other corporate actions. Valuation cannot be generalized but it should be undertaken based on its intended purpose. Ex. Valuation of shares for further issue under section 62 (1)(c) of the Companies Act, 2013 requires a valuation premise as ‘Going concern’. But the same transaction requires valuation under income tax wherein the valuer needs to follow the principles specified under Rule 11UA (2) of Income Tax Rules, 1962. Further, if these shares are issued to overseas investors, then another valuation is also needed as per FEM (Non Debt instruments) Rules,2019 based on Arm’s Length basis (ALP).
I. Valuation under Companies Act, 2013
Whenever valuation is required in respect of any property, stocks, shares, debentures, securities or goodwill or any other assets, or net worth of a company or its liabilities under the provisions of Companies Act, 2013, it shall be valued by a valuer registered with IBBI (Insolvency and Bankruptcy Board of India). The principles to be adopted and procedure to be followed for valuation are provided under valuation rules.
II. Valuation under Income Tax Act, 1961
Any transaction whether purchase, sale, transfer, exchange of either tangible or intangible asset requires valuation as per the provisions of Income tax Act, 1961 for discharging applicable tax. The Act prescribes certain rules for valuation of property. The following are types of transactions that require valuation:
– Issue or transfer of securities;
– Purchase, sale or transfer of any kind of property;
Note: Securities include— (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of alike nature in or of any incorporated company or other body corporate etc.
1. Purpose of Valuation under income tax
a. To ascertain actual capital gain for payment of capital gain tax (Section 50CA).
b. To ascertain the amount of benefit/ gain received or accrued to a recipient for payment of tax under section 56(2)(x) (gift tax).
c. To arrive excess premium (Angel tax) for payment of income tax under section 56(2)(viib) when the company offers shares at premium.
2. Provisions of Income Tax Act, 1961 for valuation of shares
a. Capital Gain tax – Section 50CA
When a consideration received or accruing on transfer of capital asset, being unquoted equity share is less than the fair market value (FMV) of such share, then fair market value of such share shall be deemed to be the full value of consideration received or accruing as a result of such transfer.
FMV for this purpose to be determined as per Rule 11UA(1)(c)(b).
b. Gift tax – Section 56(2)(x)
When a person receives from any person or persons any property, other than immovable property,—
– Without consideration, the aggregate fair market value of such property exceeds fifty thousand rupees, then the whole of the aggregate fair market value of such property shall be treated as other income.
– for a consideration less than the fair market value of the property, then fair market value of such property exceeding the consideration received shall be treated as other income.
However the following are exemptions
i. Nothing is taxable if the benefit received is less than fifty thousand rupees;
ii. Gifts to relatives and certain other transactions are exempted.
In such cases valuation is not required.
FMV for this purpose shall be determined as per Rule 11UA
c. Angel Tax – Section 56(2)(viib)
Where a company, not being a company in which the public are substantially interested, receives in any previous year, from any person any consideration for issue of shares that exceeds the face value of such shares, then the aggregate consideration received for such shares exceeding the fair market Value (FMV) of the shares, shall be chargeable to tax under the head “Income from other sources”.
Provided that this clause shall not apply
– by a *VC from a VC company or a VC fund or a specified fund; or
– by a company from a class or classes of persons as may be notified by the Central Government.
FMV for this purpose shall be determined as per Rule 11UA(2)(A)
Note* : VC- Venture capital
From the above, it is clear that any issue, purchase, sale, transfer of securities or purchase or sale of property of any kind between two parties require valuation as per Income tax Act, 1961 and valuation need to be carried out in accordance with rule 11U, UA & UAA etc., of Income tax Rules, 1962.
III. Determination of Fair Market Value
a. In case of immovable property, Guidance value for payment of stamp duty will become fair market value of such property.
b. In the case of movable property, the method of valuation depends upon the nature of the asset. Rule 11UA(1) specifies the manner for calculation of fair market value of such assets.
i. In case of listed Securities Rule 11UA(1)( c)(a) – fair market value of such securities shall be the transaction value as recorded with stock exchange. If the transaction is executed off- market trade, then the lowest price of such shares and securities quoted on any recognized stock exchange on the relevant date shall become FMV.
ii. In case of unquoted equity shares Rule 11UA(1)( c)(b) – Fair market value shall be calculated as follows
| A. Book value of all the assets (other than jewellery, artistic work, shares, securities, and immovable property) in the balance-sheet*, as reduced by: | XXX |
| i. Any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any (adv tax on profits) |
XXX |
| ii. Any amount shown as asset including the unamortized amount of deferred expenditure which does not represent asset | XXX |
| B. The price of jewellery and artistic work would fetch if sold in the open market valuation (report obtained from a RV) | XXX |
| C. Fair market value of shares and securities as determined in the manner provided in this rule | XXX |
| D. The value of immovable property based on guidance value | XXX |
| L. Book value of liabilities shown in the balance sheet excluding
a) The paid-up capital in respect of equity shares b) 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 c) Reserves and surplus, by whatever name called, d) Any amount representing excess provision for taxation e) Any amount representing provisions made for meeting liabilities, other than f) Any amount representing contingent liabilities other than arrears of dividends |
XXX |
Fair Market Value per Equity Share [A+B+C+D – L× [PV]/[PE]
*Date of Balance sheet: For arriving the fair market value of shares, the date of balance sheet to be considered:
a. For transfer of securities
The balance-sheet of such a company to be drawn up on the transaction date.
b. For issue of shares (Section 56(2)(viib)
The balance-sheet as on the transaction date and where the balance-sheet on the transaction date is not drawn up, the balance-sheet drawn up as on a date immediately preceding the valuation date which has been approved and adopted at the annual general meeting of the shareholders of the company;
iii. The fair market value of unquoted shares and securities other than equity share of a listed company 11UA(1)( c ) ( c ) (Preference shares etc,) : FMV shall be estimated to be price it would fetch if such shares or securities would be sold in the open market on the valuation date
iv. Methods of determination of Fair Market Value
a. Rule 11UA(1) prescribes valuation method for transfer of securities;
b. Rule 11UA(2) prescribes valuation method for issue of shares;
a. Valuation for Transfer of Securities (Sec 50CA & 56(2)(x) & Rule 11UA(1)
| S.no | Particulars | Rule | Method | Valuation report | Who can issue |
| 1 | Quoted Securities (equity, preference or debt instruments) | 11UA(1)(c)(a) | Transaction value through stock exchange | Not required | NA |
| 2 | Unquoted equity shares | 11UA(1)(c)(b) | Method specified in III (b) (ii) | Required | Note 1 |
| 3 | Unquoted preference shares and other securities |
11UA(1)(c)(c) | Estimated price it would fetch if sold in the open market | Required | Merchant banker or accountant |
Note 1: Who can issue valuation report: The Fair market value has to be determined based on the method prescribed (based on the balance sheet values). It can be ascertained by any person i.e Chartered Accountant, Cost accountant, Merchant banker, Registered Valuer or any other person including the Management. However, it is advisable to get a valuation report from an independent person.
b. Valuation for Issue of shares [56(2)(viib) & Rule 11UA(2)]. The Company can opt any one of the five methods for determination of fair market value :
| Rule 11UA
(2) |
A | Particulars | Method to be followed | Who can issue | Available or
not |
||
| Reside nt | Non-reside nt | ||||||
| (a) | FMV of unquoted equity share | Prescribed method | Note 1
above |
I | I | ||
| (b) | FMV of unquoted equity share | DCF | MB | I | I | ||
| (c) | VC/VCC/SF | Benchmarking price | NA | I | I | ||
| (d) | FMV of unquoted share – Merchant Banker – 5 methods | One of the five specified methods # | MB | × | I | ||
| (e) | Notified entity – | Benchmarking price | I | I | |||
VC- Venture capital, VCC- Venture capital company, SF – Specified Fund, MB- Merchant Banker, DCF – Discounted cash flow method
# specified methods:
– Comparable Company multiple method
– Probability weighted Expected Return method
– Option Pricing Method
– Milestone analysis method
– Replacement cost method
Note Provisions of Rule 11UA(2) amended w.e.f. 25th September, 2023
Any one of the above methods can be opted for arriving fair market value for issue of shares. However if the Shares are offered to domestic investors other than overseas investors, the option mentioned (d) is not available and they need to select one of the other four methods.
v. Other requirements
– Safe Harbor Rule (Rule 11UA(4)
The issue price can exceed up to 10% of the fair market value determined as per the specified methods. In such issue price shall be deemed to be fair market value.
Valuation report obtained from Merchant Banker is valid up to 90 days from the date of issue.
III. Practical issues and challenges in decision making
a. Issue of shares
– As per section 56(2)(viib) of Income tax Act, 1961 , shares shall be issued at or below the fair market value (higher cap) where as Share Capital and Debenture Rules (Rule 13) under Companies Act, 2013 mandates shares shall not be issued below (lower cap) the fair price per share as determined by the registered valuer.
b. Rights issue of shares with premium
If an unlisted Company offers rights issue to its existing shareholders on disproportionate basis, then valuation report is required in such a case to identify the benefit accrued due to such dis-proportionate allotment. However, there are contrary judgements on this issue.
c. Transfer of shares
– If unquoted equity shares are sold at below the fair market value, then fair market value of such shares are taken as consideration for sale of shares and accordingly the capital gain is calculated (tax impact to Seller) (Section 50CA).
– Same transaction is treated as benefit received to a buyer as per section 56(2)(x) and differential amount is liable for payment of income tax (to buyer) treating the same as benefit accrued or received.
To avoid such additional income tax liability, it is recommended to transfer the shares at fair market value always.
IV. Summary of valuation requirements as per Income Tax Act
| Particulars | Valuation |
| Listed securities (Equity shares, preference shares, or debt instruments) | Not required.
The market price is considered as FMV |
| Un-listed Securities | |
| 1. Rights issue of shares | Not required unless allotment is on dis- proportionate basis. In such a case there are contrary judgements |
| 2. Issue of securities on Preferential basis | Required unless preferential offer is at par value |
| 3. Bonus shares | Not required. |
| 4. Shares buy back | Not required as the Company pays buy back tax |
| 5. Exchange of shares during amalgamation, merger or demerger |
Not required. |
Conclusion: Navigating the intricacies of securities valuation under the Income Tax Act demands expertise and adherence to regulatory nuances. Understanding valuation provisions, challenges, and practical implications is essential for tax compliance and informed decision-making in the corporate landscape.
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Disclaimer: Views expressed here are personal views of the author and should not be considered as legal opinion.
CS Chandra Sekhar Kandukoori | M.Com, LLB, ACS, ACMA, (CA), qualified social auditor | Practicing Company Secretary, Insolvency Professional and Registered Valuer
Author can be reached at [email protected]
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