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Transaction Tax

08 May 2017

CBDT issues draft notification amending the existing valuation norms for unquoted equity shares for transactions covered under Section 56(2) and Section 50CA of the Income-tax Act, 1961 (‘ITA’)

Introduction

The Central Board of Direct Taxes (‘CBDT’), on May 05, 2017, has released draft notification amending the existing Rule 11UA of the Income-tax Rules, 1962 (‘Rule 11UA’) proposing a change in valuation rules for unquoted equity shares with respect to transactions covered under Section 56(2) of ITA. Section 56(2) of the ITA imposes tax on differential value where any person receives unquoted shares at a price less than the value arrived at as per Rule 11UA.

The amended Rule 11UA is proposed to become effective from April 01, 2017.

A comparative analysis of the existing Rule 11UA and proposed change to Rule 11UA dealing with valuation of unquoted shares for the purposes of Section 56(2) is summarized in the table below:

Existing Rule 11UA(1)(c) – sub clause (b)

Proposed Rule 11UA (1)(c) – sub clause (b) – [with proposed insertions in Bold Italics and proposed deletion through strike off mode]

Fair market value of unquoted equity shares =

            (A–L) × (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:—

 

  1. the paid-up capital in respect of equity shares;

  2. 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;

  3. reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

  4. 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;

  5. any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

  6. 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

 

 

 

 

 

 

 

 

 

 

 

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) as reduced by,-
(i) any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any, and
(ii) any amount shown 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:—

  1. the paid-up capital in respect of equity shares;

  2. 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;

  3. reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

  4. any amount representing provision for taxation, other than amount of income tax paid, if any, less  as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund, if any, 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;

  5. any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

  6. 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 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

 

Further to amendment to Rule 11UA (applicable to Section 56(2)), CBDT has proposed to apply the same valuation methodology for computing capital gains under Section 50CA of ITA by inserting Rule 11UAA. As per Section 50CA (which was inserted in Budget 2017), where consideration for transfer of unquoted shares is less than the fair market value (‘FMV’), as determined in accordance with the manner to be prescribed, such FMV is deemed to be the full value of consideration for computing capital gains. The manner for computing FMV for Section 50CA was pending to be issued and is now proposed to be in identical to FMV to be used for transactions covered under Section 56(2) of ITA.

Rule 11UAA is also proposed to be with effect from April 01, 2017.

Key takeaways

  • For tax purposes, valuation of unquoted equity shares of a company, which has jewellery, artistic work, immovable property and investment in shares / securities of other companies, would need to factor value of these assets as per valuation methodology proposed instead of book values of these assets. This is a significant change from the prevailing valuation norm for unquoted equity shares. Practical difficulties could prevail in valuing unquoted equity shares of company which holds minority investments in multiple companies.
  • Further, as per prescribed Rules, valuation need to be carried out based on audited accounts as on the date of transfer. This could again pose practical difficulties especially for valuing unquoted shares of a company which holds other unquoted investments and/or which has multi-layered downstream investments in other unquoted companies. This would also add up the cost of consummating transactions.
  • Irrespective of the time of declaration of dividend, such dividend shall now be excluded from liabilities while calculating fair market value. This amendment is a welcome move because generally there is a time lag between date when dividend is proposed by the Board of Directors and when such dividend declaration is affirmed by the shareholders.
  • The Rules are proposed to be applicable from April 01, 2017 and onwards, which could create issues for transaction involving unquoted equity shares already undertaken from April 01, 2017 till now.

We expect that there could be further amendments / clarifications to these draft rules by the time the same are finalised. We shall keep you posted on the developments. Meanwhile, if you have any comments / suggestions to the proposed amendment, please feel free to write to us at [email protected]