Tax Alert - Valuation Rules for Unquoted Shares
14 July 2017
Final rules prescribing methodology of valuation of unquoted shares
Section 56(2)(viib) of the Income-tax Act, 1961 provides for taxation of consideration received by company in excess of fair market value of shares issued. The Finance Act, 2017 enacted a new section 56(2)(x) that seeks to tax recipient of movable property, inter-alia covering shares and securities that are received without consideration/inadequate consideration as compared to the fair market value of shares. Another new section 50CA introduced by Finance Act, 2017 for computation of capital gains, deems the fair market value of unquoted shares as consideration of transfer, if actual consideration is less that fair market value.
For determination of fair market value of unquoted shares for the purposes of above provisions, the Central Board of Direct Taxes (‘CBDT’) had issued draft rules on May 5, 2017 for public consultation. Please refer our update on draft rules dated May 8, 2017 : Transaction Tax Alert. On July 12, 2017, the CBDT has notified final rules that are largely in line with the draft rules released earlier.
THE FINAL RULES
Though the valuation mechanism of unquoted shares remains the same as that of draft rules, the final rules have made some modifications as below:
- For underlying assets other than jewellery, shares, securities, etc., where book value of assets is to be considered for Rule 11UA, the final rules now specifically provide that such book value of assets and liabilities shall be the value as shown in the “balance sheet”.
- The draft rules proposed exclusion of amount set apart for payment of dividends on preference and equity shares from the book value of liabilities for Rule 11UA. The final rules prescribe that such dividend should be excluded only if such dividends have not been declared before the date of transfer at a general body meeting of the company.
- For the purposes of section 50CA, Rule 11UAA has been prescribed that is linked to the valuation rules prescribed in Rule 11UA for provisions of section 56(2). While the draft rules of Rule 11UAA covered only the valuation mechanism of unquoted equity shares, the final rules have also referred to the valuation mechanism of unquoted shares and securities other than equity shares. The Rule 11UAA also provides that valuation date shall be the date on which such unquoted shares are transferred.
These rules will be applicable from the fiscal year beginning on April 1, 2017.
The changes incorporated in final rules have provided clarity to taxpayers for computation of fair market value by addressing some issues arising from draft rules. However, certain pitfalls and practical difficulties in application of rules still need to be taken note of, that include:
- valuation of shares of an overseas company listed on stock exchange outside India, where the price as listed on stock exchange may differ substantially from the value arrived as per method prescribed in new rules;
- practical challenge of having audited balance sheet as on date of transaction for calculation of fair market value
- valuation exercise in case of inter-locked investments or cross-holding amongst companies
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