Valuation of unquoted equity shares under Income Tax in case of transfer of shares and shares issued by company at premium
[IN CASE OF ISSUE AND TRANSFER OF SHARES]
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.
As per Section 56(2)(x) of Income Tax Act 1961, in case any shares or securities are transferred at a value that is less than the Fair Market Value, the difference shall be charged to tax in the hands of the buyer.
Fair market value under the Income Tax Act for the purpose of secondary sales of shares shall be computed in the following ways:
- In the case of a listed company, it shall be listed price
- In the case of an unlisted company, it shall be computed using the formula prescribed under Rule 11UA (i.e., Book Value)
Please note that there are no related provisions on the Valuation of shares under the Companies Act with respect to the transfer of Shares. As per FEMA Regulations (Non-Debt Rules, 2019), when shares are transferred from a Non-Resident to Resident or vis-à-vis, the transaction price shall be greater than the value derived by CA or merchant banker using an internationally accepted methodology.
Please note that-
- Rule 11UA(1) is applicable in case of Section 56 of the IT Act for determine the fair market value of the property other than immovable property.
- Whereas Rule 11UA(2) is applicable in case of Section 56(viib) (i.e. shares issued by the company at premium).
Rule 11UA(1) prescribes the manner to find out the fair market value of the following property
a) Valuation of Jewellery
b) Valuation of archaeological collections, drawings, paintings, sculptures or any work of art.
c) Valuation of shares and securities
a) Fair market value of quoted shares and securities
b) Fair market value of unquoted Equity shares (see formula).
c) Fair market value of unquoted shares and securities other than Equity shares. [fair market value of unquoted shares and securities other than equity share in a company which are not listed in any RSE 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.]
Whereas Rule 11UA(2) prescribes the manner to find out the fair market value of the unquoted equity shares in case of shares issued by the company at premium under Section 56(viib) of IT Act with two options at the choice of the assessee.
Option (a): calculate the fair market value of unquoted equity shares as per formula given in this option.
Option (b): the fair market value of unquoted equity shares determined by a merchant banker as per the Discounted Free Cash Flow Method.
Conclusion: With above discussion, it is clear that in case of transfer of shares of unquoted equity shares, the fair market value of unquoted equity shares shall be determined as per formula given in Rule 11(UA)(1)((c)(b).There is no need to obtain any report from merchant banker or an accountant in respect of such valuation. However, in case of Rule 11UA(2), if an assessee choose the valuation of unquoted equity shares as per the Discounted Free Cash Flow Method, then he has to obtain a report from Merchant Banker.
FAIR MARKET VALUE OF THE UNQUOTED EQUITY SHARES IN CASE OF SHARES ISSUED BY THE COMPANY AT PREMIUM UNDER SECTION 56(VIIB) OF IT ACT.
As defined under Rule 11UA(2), the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under (a) or (b), at the option of the assessee, namely; –
Option (a):
The fair market value of unquoted equity shares shall be calculated simply by ascertaining “Book value of Assets (Less) Book value of Liabilities.”
Fair Market Value of Unquoted Shares = (A-L) X (PV)
(PE)
Where,
A= book value of the assets in the balance-sheet but not including as mentioned below.
L= book value of liabilities shown in the balance-sheet, but not including as mentioned below.
PE= total amount of paid-up equity share capital as shown in the balance-sheet
PV= the paid-up value of such equity shares.
For ascertaining the book value of assets, following amounts shall be excluded:
- Advance Tax, Tax deduction or collection at source or any amount of tax paid as reduced by refund claimed under the Income Tax Act.
- any unamortized amount of deferred expenditure which does not represent the value of any asset.
For ascertaining the book value of liabilities, following amounts shall be excluded:
- the paid-up capital in respect of equity shares;
- the amount set apart for payment of dividends on preference or equity shares
- 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 reduced by the amount of tax claimed as refund
- 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.
Option (b):
The fair market value of the unquoted equity shares as determined by a Merchant Banker as per Discounted Free Cash Flow Method.
Earlier, a Chartered Accountant was also permitted to determine the FMV of such equity shares. However, with effect from 24th May 2018, this right of Chartered Accountant is taken away and therefore only Merchant Banker is authorised to determine the FMV of such equity shares.
FAIR MARKET VALUE OF THE UNQUOTED EQUITY SHARES IN CASE OF SECTION 56(2)(x) OTHER THAN UNDER SECTION 56(viib) OF IT ACT.
In case of transfer of shares of unquoted equity shares under section 56(2)(x) of IT Act, the fair market value of unquoted equity shares shall be determined as per formula given in Rule 11(UA)(1)((c)(b). There is no need to obtain any report from merchant banker or an accountant in respect of such valuation.
As defined under Rule 11(UA)(1)((c)(b),the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner –
The fair market value of unquoted equity shares shall be calculated simply by ascertaining “Book value of Assets & Others (Less) Book value of Liabilities.”
Fair Market Value of Unquoted Shares = (A+B+C+D-L) X (PV)
(PE)
Where,
A= book value of the assets in the balance-sheet but not including as mentioned below.
L= book value of liabilities shown in the balance-sheet, but not including as mentioned below.
B= the price which the jewellery 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
PE= total amount of paid-up equity share capital as shown in the balance-sheet
PV= the paid-up value of such equity shares.
For ascertaining the book value of assets (other than jewellery, artistic work, shares, securities and immovable property), following amounts shall be excluded:
- any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and
- any unamortized amount of deferred expenditure which does not represent the value of any asset.
For ascertaining the book value of liabilities, following amounts shall be excluded:
- the paid-up capital in respect of equity shares;
- the amount set apart for payment of dividends on preference or equity shares
- 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 reduced by the amount of tax claimed as refund
- 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.
Valuation Date- means the date on which the property or consideration as the case may be , is received by the assessee.
Balance Sheet- as on date immediately preceding the valuation date which has been approved and adopted in the annual general meeting of the shareholders.
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The entire section of giving powers to AO to check if the premium is excess or less is wrong. Also, why restrict to only one method – Discounted Cash Flow? There are other methods – Gross Merchandise Valuation, Revalued assets value. and all these valuations are subject to negotiations etc.
Further, the Honourable Supreme Court had held in the BALCO disinvestment case that the value of any asset is what the highest bidder is willing to pay.
Its unfair on the department to step into the puddle. It should only ascertain the old requirements of identity and credit worthiness.