Transfer of shares below FMV - a double taxation enigma

May 18,2017
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Nilesh Vichare (Executive Director, EY)

The Budget 2017 was a balancing act which aimed to provide an impetus to the Indian economic environment and also took steps towards plugging abuse of tax provisions. A key agenda of the Budget revolved around curb of anti-abusive practices, a key aspect being transfer of shares below fair market value (‘FMV’).

The existing provisions of S. 56(2)(vii) of the Income Tax Act, 1961 (‘Act’) provide for the taxation of receipt of specified assets for inadequate or without consideration in the hands of individuals or HUFs. Whereas the provisions of S. 56(2)(viia) of the Act provide for the taxation of receipt of shares of a closely held company by another closely held company/firm for inadequate or without consideration. The proposed new S. 56(2)(x) will expand both the category of assets and recipients under the tax net. Section 56(2)(x) provides for taxability of receipt of specified property sum of money by any person in the hands of the recipient, if the receipt is made without consideration or for inadequate consideration in excess of Rs. 50,000.

Separately, the newly introduced S. 50CA provides that where consideration for transfer of share of a company (other than quoted share) is less than the fair market value of such share (determined in accordance with the prescribed manner), the fair market value shall be deemed to be the full value of consideration under the head ‘capital gains’. This section is one more addition in anti-abuse provisions. At the time of enactment of the Finance Act, clarity was awaited on the method of determining such fair market value for the purpose of S. 50CA.

By way of enactment of S. 50CA and S. 56(2)(x) in the Act, the government intended to plug the probable loss, occurring to the revenue on account of understatement of consideration on transfer of unquoted shares. However, in doing so, it resulted in a potential double taxation.

While S. 50CA shall impose tax on the difference between the FMV and the consideration received for transfer of shares as capital gains in the hands of transferor, S. 56(2)(x) shall tax the same difference in the hands of the transferee of such shares. The aforesaid computational mechanism shall lead to taxation of the same amount of consideration in hands of two tax payers ie, the transferor and transferee.

The Central Board of Direct Taxes (CBDT) has recently released amendment to Rule 11UA for valuation of unquoted equity shares for the purposes of S. 56 and S. 50CA of the Income-tax Act, 1961. The amended Rule 11UA is proposed to become effective from 1 April, 2017. In other words, the manner for computing FMV for S.50CA proposed in the draft rules are identical to FMV to be used for transactions covered under S.56(2) of ITA.

A summary of the proposed changes to Rule 11UA dealing with valuation of unquoted shares is is as follows:

· The FMV of unquoted equity shares, as on the valuation date, shall be equal to

(A+B+C+D-L) x (PV /PE)

where

PV means the paid-up value of equity shares

PE means the total amount of paid-up equity share capital as shown in the balance sheet

· A is book value of all assets other than jewellery, artistic work, shares, securities and immovable property, as reduced by:

- Any amount of income tax paid, if any, as reduced by the amount of tax claimed as refund, if any, under the ITL.

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