Dealing with Deals - M&A Tax in Focus!

Valuation norms for unquoted stock – Book value no longer “fair”

May 10,2017
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Hiten Kotak ( M&A Tax Leader, PwC India)

Falguni Shah ( M&A Tax Partner, PwC India)

The Central Board of Direct Taxes has recently issued draft rules for determining the fair market value of unquoted equity shares for the purposes of section 56 (2)(x) and section 50CA of the Income-tax Act, 1961 and it has invited comments from the public on the same. The last date for the receipt of comments by CBDT is 19 May, 2017.

In this article we have analysed the proposed rule to understand how the fair value of unquoted equity shares will be computed, manner in which it is different from the erstwhile rules and identified various open issues which would require further clarity from the department.

The Finance Act, 2017 has inserted section 50CA in the Income Tax Act, 1961 (ITA), with effect from 1 April, 2018 (i.e., assessment year 2018-19), which provides that where the consideration received or accruing, on transfer of unquoted shares of a company, is less than the Fair Market Value (FMV) of such shares, determined in accordance with the prescribed manner, the FMV shall be deemed to be the full value of consideration for computing income under the head “Capital gains.”

Similarly, the Finance Act, 2017 has also inserted clause (x) in section 56(2) in the ITA. Prior to its insertion, section 56(2)(vii) and section 56(2)(viia) of the ITA had a similar taxing framework—except for the fact that the former applied only to individuals and HUFs on any sum of money or specified property received by them without consideration or for inadequate consideration, while the latter applied to only receipt of shares of a closely held company by another closely held company or firm without consideration or for inadequate consideration.

Section 56(2)(x)has widened the ambit of taxability of such receipts and is now applicable to all assessees. It provides that any sum of money or specified property received without consideration or for inadequate consideration with effect from 1 April, 2018 (i.e., assessment year 2018-19) will be subject to tax. Although the scope of taxability was widened the valuation rules remained unchanged, i.e., it made a reference to Rule 11UA of the Income Tax Rules, 1962 (the Rules), which prescribed that unquoted shares of a company would be valued at book value (subject to some adjustments).

The Central Board of Direct Taxes (CBDT) on 5 May, 2017 released the draft rules for computing FMV of unquoted shares of a company under section 50CA and section 56(2)(x). It would be interesting to see how share transfers (of unquoted shares) executed after 1 April, 2017 but before the date of notification of these rules are dealt with by the tax department.

These rules seek to replace the existing sub-clause (b) of clause (c) of sub-rule(1) of Rule 11UA of the Rules. As per the Proposed Rule 11UA(1)(c)(b), the FMV of the unquoted equity shares will be computed as follows.

FMV of unquoted equity shares = (A+B+C+D-L) X PV/PE where

A

Book value of all the assets (except B, C and D below) subject to certain adjustments

B

Fair market value of jewellery and artistic work based on the valuation report of a registered valuer, i.e.,

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