“CBDT has notified the final rules prescribing ‘fair market value’ method for valuation of unquoted shares. The amended rules are called the Income-tax (20th Amendment), Rules, 2017 for Sections 56(2)(x) and 50CA, are broadly in line with the draft rules released by the CBDT in May. The amended rules shall come into force from April 1, 2018 and shall apply in relation to assessment year 2018-19 and subsequent years.”

Background

Finance Act, 2017 inserted two new provisions under the Act- clause (x) under Section 56(2) and section 50CA. The said sections were inserted to deal with a situation where the property, including unquoted shares, are being transacted for inadequate consideration much below the FMV of such property.

• Insertion of clause (x) in section 56(2) to provide that receipt of money or specified property by any person for inadequate consideration or without consideration from any person shall be subject to tax.
• Introduction of section 50CA to provide that where consideration for transfer of shares of a company other than a quoted share is less than the FMV of such share, the FMV determined as per the Rules shall be deemed to be the full value consideration for computing income under the head “capital gains”.

The CBDT had issued a draft notification in May 2017 that proposed to amend Rule 11UA and to introduce Rule 11UAA for computing the FMV of unquoted shares of a company for the purpose of Sections 56(2)(x) and 50CA respectively.

Thus, in case of transaction involving transfer of unquoted shares, the aforesaid computational mechanism seeks to tax the same differential amount of consideration and FMV in hands of both tax payers i.e., the transferor and transferee.

It is further important to note that clause (x) under section 56(2) has widened the scope of the provisions as the same becomes applicable for all taxpayers unlike provisions of clauses section (vii) and (viia) of section 56(2) of the Act which were applicable to selected taxpayers.

Final Rules Prescribed

For valuation of the unquoted shares, clause (x) under section 56(2), even after insertion, continued to make reference to provisions of Rule-11UA as was applicable for clauses section (vii) and (viia) of section 56(2) of the Act. The CBDT, however, came out with the drafted amended Rule-11UA which were at variance with the erstwhile Rule-11UA.

The CBDT has now notified the amended Rule-11UA which provides for valuation of unquoted equity shares, as per the following formula:

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

where

A - Book value of all the assets (except those mentioned at B, C and D below) as reduced by income tax paid (net of refund) and unamortised deferred expenditure

B - Fair market value of jewellery and artistic work based on the valuation report of a registered valuer

C - Fair market value of shares or securities as determined according this rule

D – Stamp duty valuation in respect of any immovable property

L - Book value of liabilities, excluding paid up equity share capital, amount set apart for undeclared dividend, reserves and surplus, provision for tax, provisions for unascertained liabilities and contingent liabilities

PV - Paid up value of equity shares

PE - Total amount of paid up equity share capital as shown in the balance sheet.

It is important to note that the book value has to be determined as per the ‘balance sheet’, which term has been defined under Rule-11U to mean the audited accounts of the company as drawn upto the ‘valuation date’.

“The rules state that the fair market value of unquoted equity shares will include the book value of all assets other than jewellery, artistic works, shares, securities and immovable property, and increased by the open market value of jewellery or artistic trust and shares, value adopted for payment of stamp duty for immovable properties. ”

The Impact

It has been observed that the erstwhile Rule 11UA(1)(c)(b) determined FMV of unquoted equity shares wholly on the basis of book value of the company without considering valuation impact relating to assets for which specific valuation rules were provided and thus, there was an inconsistency in direct and indirect valuation of certain assets. The amended rule 11UA(c)(b) removes above inconsistency and provides valuation adjustment for such assets in valuation of unquoted equity shares of company holding such assets.

Valuation of rest of the assets, including assets such as intangible assets, business undertaking, investment held in Limited Liability Partnership or partnership firm etc., and liabilities of the company continues to be valued at book value.

• Newly inserted Rules 11UAA provides valuation methodology to be adopted for the purpose of new section 50CA. It provides that equity shares covered thereunder should be valued as per above Rule 11UA(1)(c)(b) and preference shares should be valued as per Rule 11UA(1)(c)(c) which provides for valuation it will fetch if sold in open market.
• Final Rules have not addressed some issues which were necessary and were expected to be addressed:
• Adoption of actual fair value, in case the FMV of immovable property is less than the Stamp Duty Value;
• Reduction in relation to securities premium payable on redemption of preference shares,
• Rules being notified on 12th July, 2017 and being made effective from 1st April, 2017, relaxation should have been provided to transactions entered between 1st April, 2017 and 12th July, 2017. 
  

The above rule, as notified, has been made applicable from April 1, 2017 and as such, all those transactions which took place during the period of April 1, 2017 and the date of notification of amended Rule 11UA, shall also be governed by such amended Rule 11UA. This, however, means that the Rule-11UA have been given a little retrospectivity.

That apart, the amended Rule 11UA mandates that stamp duty valuation (assessed/assessable) should be adopted for valuing any immovable property. The issue that would arise that whether such stamp duty valuation would still be adopted in case of a company having real estate business holding immovable property as stock-in-trade? If yes, then, it would have severe impact on such real estate companies.

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Acquisory News Chronicle - July 2017