SELECTIVE CAPITAL REDUCTION

Capital reduction refers to corporate reorganisation activity in which the existing share capital is
extinguished. Companies consider utilising this route for various business reasons, such as
returning excess capital to shareholders, distributing assets to shareholders, loss of original share
capital due to accumulated business losses, etc.
The process of capital reduction might affect all shareholders or certain shareholders, depending
upon business requirements. When the capital reduction process targets specific shareholders or a
class thereof, the process is known as selective capital reduction. One example of such capital
reduction is minority buyouts.
It would be pertinent to examine the relevant provisions of the Income-tax Act, 1961(ITA), as
shall be applicable in case of selective capital reduction. Under section 45 of the ITA, any profits
or gains arising from the transfer of a capital asset shall be chargeable to income tax under the
head “capital gains.” Considering that the shares in this case shall be considered capital assets
and the definition of “transfer” includes extinguishment of any right, it may be inferred that
reduction of share capital may be considered as transfer of capital asset and appropriate capital
gains tax may be applicable.
The Finance Ministry, in its 2017 budget, introduced section 50CA to the ITA (effective from
Assessment Year 2018-19), which provides that where the consideration received or accruing as
a result of transfer of an unquoted share is less than the fair market value (FMV) as on the date of
transfer, the FMV shall be treated as the full value of consideration for the purpose of
computation of capital gains under section 48.
Thereby, section 50CA may be applicable to selective capital reduction to determine the full
value of consideration, which shall be the amount payable by a company pursuant to reduction of
share capital for the purposes of computing capital gains.
Additionally, it would be worthwhile to delve into a case of selective capital reduction, wherein
capital reduction undertaken by the company does not result in any payout to the shareholders,
i.e., a capital reduction without payment of any consideration.
As per section 50CA, there should be consideration “received” or “accruing” as a result of
transfer of unquoted shares. In this regard, judicial precedents discussing the meaning of
“accrue” and “receive” are provided below:
In the case of CIT v. Annamalais Timber Trust,[1] on the meaning of the terms “accrue” and
“receive,” the Court opined that “accrue” is “to arise or spring as a natural growth or result” and
may be interpreted as present enforceable right to receive income, profits or gains and is capable
of “being enforced or converted into money by actual receipt.” On the other hand, the word
“receive” means actual receipt income, profits or gains.
Further, in the case of CIT v. Ashokbhai Chimanbhai,[2] with respect to the meaning of the said
terms, the Court observed that income is said to be received when it reaches the assessee,
whereas when the right to receive the income becomes vested in the assessee, it is said to accrue
or arise.
Accordingly, it may be inferred from judicial precedents that the term “accrue” conveys the idea
of a present enforceable right to receive and the term “received” means that there is an actual
receipt of consideration.1
Thus, one may contend that the terms “received or accruing” in section 50CA do not envisage a
situation of “no consideration” and section 50CA may not be applicable where no consideration
is envisaged.
Another aspect to be considered is the applicability of section 56(2)(x) of ITA in the hands of
other shareholders who did not participate in capital reduction. Section 56(2)(x) provides that
where any person receives in any financial year, any shares and securities without consideration,
the FMV of which exceeds INR 50,000, the whole FMV of such shares and securities shall be
chargeable to tax under section 56(2)(x) in the hands of the transferee.
In the case of Sudhir Menon HUF v. ACIT, [3] the Tribunal held that a proportionate issue of
shares at a price below the FMV to all shareholders of the company may not lead to any tax
implications under section 56(2)(viia)). One wonders whether any disproportionate issue of
shares, i.e., issue of shares to a particular shareholder or a group of shareholders at a price lower
than the FMV may lead to taxability under section 56?
However, in a capital reduction scenario, vis-à-vis the remaining shareholders, what happens is
merely an enlargement of rights and interests of other shareholders and there is no “receipt” of
shares or assets, and hence, section 56(2)(x) may not apply. However, the jury is however still
out on this interpretation and one should wait for some precedents before any conclusions.
Views expressed are personal to the author. Article includes inputs from Janardhan Rao Belpu –
Director – M&A Tax, PwC India, Komal Jain – Assistant Manager – M&A Tax, PwC India and
Sambit Das – Assistant Manager – M&A Tax, PwC India
[1] [1950] 18 ITR 333 (Mad)
[2] [1965] 56 ITR 42 (SC)
[3] TS-146-ITAT-2014 (Mum)
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
NEW SECTION 50CA
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”.
Explanation.—For the purposes of this section, “quoted share” means the share quoted on any
recognised stock exchange with regularity from time to time, where the quotation of such share
is based on current transaction made in the ordinary course of business.’.
AMEND RULE 11UA
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.
The fair market value of unquoted equity shares shall be the value, on the valuation date, of such
unquoted equity shares as determined in the following manner-
The 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) in the balance-sheet 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 unamortized amount of deferred expenditure which
does not represent the value of any asset;
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;
L= book value of liabilities shown in the balance sheet, but not including the following amounts,
namely:—
(i)the paid-up capital in respect of equity shares;
(ii)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;
(iii) Reserves and surplus, by whatever name called, even if the resulting figure is negative,
other than those set apart towards depreciation;
(iv)any amount representing provision for taxation, other than amount of income-tax paid, if any,
less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax
payable with reference to the book profits in accordance with the law applicable thereto;
(v) Any amount representing provisions made for meeting liabilities, other than ascertained
liabilities;
(vi) Any amount representing contingent liabilities other than arrears of dividends payable in
respect of cumulative preference shares;
PV= the paid up value of such equity shares;
PE = total amount of paid up equity share capital as shown in the balance-sheet

New Rule 11UAA prescribes that for the purposes of section 50CA, the FMV of the share of a
company other than a quoted share, shall be determined as provided in Rule 11UA(1)(c)(b)/
(c), and that the reference to valuation date in the rule 11U and rule 11UA shall mean the
date on which such shares are transferred.
the fair market value of unquoted shares and securities other than equity shares in a company
which are not listed in any recognized stock exchange shall be estimated to be price it would
fetch if sold in the open market on the valuation date and the assesses may obtain a report from a
merchant banker or an accountant in respect of which such valuation.
Where consideration for transfer of share of a company (other than quoted share) is less than the
FMV of such shares determined in accordance with the manner to be prescribed, the FMV shall
be deemed to be the full value of consideration for computing Capital Gains.
Quoted share - Shares quoted on any recognised stock exchange with regularity from time to
time, where the quotation of such share is based on current transaction made in the ordinary
course of business
For Example
ABC and Co. (Seller) acquired 10,000 shares of a private limited company at INR 100 per share.
The shares were sold by ABC to XYZ and Co. (Buyers) at INR 150 per share. The FMV of the
shares on the date of transfer was INR 170 per share. 3 The impact of the section 50CA would be
as follows.
Particulars Under Old Provisions After Amendment Delta
Sale Consideration 15,00,000 17,00,000 2,00,000
(150 X 10,000) (170 X 10,000) {(170-150) X 10,000)
Less: Cost of 10,00,000 10,00,000 NIL
Acquisition
(100 X 10,000) (100 X 10,000)
Capital Gains 5,00,000 7,00,000 2,00,000*

*The differential amount taxed on account of introduction of section 50CA in the hands of ABC
and Co. (Sellers) amounts to INR 200,000. The said amount is being taxed as a result of increase
in sale consideration from INR 15,00,000 to INR 17,00,000.
Impact on Buyer for the amendment in Section 50CA
In order to curb the practice of receiving shares without consideration or for inadequate
consideration, it has been proposed to insert a new clause (x) under section 56(2). This section
provides for taxability in the hands of the purchaser of shares if the purchase is made without
consideration or for consideration less than the FMV of such property. Further, in line with the
extant provision of the Act, this provision would only trigger if the difference between the
consideration paid and the FMV exceeds INR 50,000. With the introduction of this clause, the
scope of the extant provision has been expanded to all the tax payers.
Consequently, clauses (vii) and (viia) of section 56(2) of the Act would not be applicable post 01
April, 2017. Furthermore, in line with the relief available under the extant provisions,
amendment has also been proposed to take into account the FMV of the shares as their cost of
acquisition in case the provisions of section 56(2)(x) are triggered.
For Example
As per above example, Computation of income from other sources in the hands of XYZ and Co.
(Buyers)-

Particulars Under Old Provisions After Amendment Delta

FMV of Shares 17,00,000 17,00,000 Nil
(170 X 10,000) (170 X 10,000)
Less: Actual Amount 10,00,000 10,00,000 NIL
for Shares
(100 X 10,000) (100 X 10,000)
Capital Gains 7,00,000 7,00,000 Nil
From the above example, it may be seen as per the extant provisions of the Act, the amount of
INR 200,000 was being taxed in the hands of transferee. However, the section 50CA proposes to
tax the amount of INR 200,000 in the hands of transferor. Consequently, the amount of INR
200,000 is being taxed in the hands transferor as well as transferee.
The aim to bring anti-abusive measures is to bring into the tax net the amounts, which avoided
tax by way of understatement of full value of consideration. Having said so, the taxation as per
sections 50CA and 56(2)(x) may result into incidence of double taxation.
Impact on Startups-
The Impact of amendments in Income Tax effects in the whole society, the start-ups going to
effect with too as they are in developing stage in industry need to do compliances so at every
point of time
Start-Ups need investments in way of Loans, Debentures and Share issuance and many of Start-
ups shares are not listed anywhere so the shares issue by them are treated to be as the “Unquoted
Shares” which curbs the impact of Section 50CA and Section 56(2)(x)
As described earlier, Sections amended w.e.f. April 01 2017 will cause the double taxation in
hands of seller as well as buyer for the difference of the amount of FMV and Sales price ( if
greater than INR 50,000). Start-ups seeking for the investments need to calculate the FMV of
there shares as per the prescribed method as described in Rule 11U(A) for calculation of the
values of shares so that the impact of taxation is not doubly tax the income.
Any Income received from the investor in against of the share issued by the company may
impact the virtue of the section 50CA and 56(2)(x)
Investor (The Buyer) of shares has also to overlook the amount of investments to be made by
him in the start-up by looking the financials of Start-ups for the capital gains by calculating the
FMV of shares of the company.
Start-ups have also to quote the number of share allotment needed to make in against of the
investments to be done by the investors. Non- Compliance of any of the purview of section of
income tax act 1961 is not good for any start-Ups looking for good investors and want to run in
long term basis so have to update from each and very update related to compliances which will
helps them to run in better way.
Section 50CA and Section 56(2)(x) are in effect, for taxability of the differential amount, greater
than the INR 50,000 , between FMV and Sale price of the unquoted shares which will helps in
reducing window dressing of the investments amount or routing the way of investors amounts to
come in startups.
So the main motive of amendment is to lower the practice of tax evasion by application of the
taxes on the amount twice if in case it’s intentionally done.
Buying or selling equity shares in India is covered by multiple laws – the Companies Act 2013,
SEBI regulations, FEMA regulations, anti-competitive law (on occasion). Income tax, however,
is usually applicable irrespective of the circumstances of the transaction. In equity share
transactions, most buyers assume that tax valuations are required for capital gains, but miss the
fact that tax under the head "other income" may be triggered. Tax valuations are actually required
frequently, in order to support the buyer and seller's position to the tax authorities.
Tax valuations and Capital Gains tax
The understanding of tax valuations and capital gains tax is fairly straightforward. Section 45
covers all capital assets that may be sold (thereby including shares in a company, whether listed
or unlisted). Section 48 provides the mode of computation of capital gains, stating that:
Capital gains = Selling price (-) Cost of acquisition (-) Any related selling costs
Tax would be charged on such capital gain at the rate of 10% without indexation benefits or 20%
with indexation benefits. There are exceptions and provisos (e.g. for non-residents selling shares
in an Indian company) however capital gains are well-understood by most.
Section 50CA tax valuations
When an entity sells equity shares held in a private company, if the consideration received is less
than fair market value (FMV), the FMV will be substituted for the consideration. Capital gains
tax must then be computed on the difference between FMV and cost.
E.g. If Company X sells its shares in Company Y where cost of shares is 100, sale price is 150
and FMV is 200: X will be taxed on (200-100) instead of (150-100).
Section 56 tax valuations
The intent behind Section 56 (which covers miscellaneous income sources) was originally to tax
income such as interest, gifts received, dividends, etc. However it has been broadened to include
income and notional income from sale of shares. This is done by including the following:
Subsection (viib): When a private company raises capital from a resident at a premium to face
value of shares, the amount that exceeds the fair value of the shares is considered "other
income". This clause excludes funds received from a VC firm.
E.g. If Company A raises ₹ 100 of capital against a face value of shares of ₹ 30 and the fair
value is calculated to be ₹ 50, the company will be taxed on ₹ 50 (100-50).
Subsection (x)(c): When any entity receives shares for a consideration that is nil or less than
FMV by over ₹ 50,000, the difference between the FMV and consideration will be treated as an
income. This in effect is a "bargain purchase" provision that attempts to tax a recipient of any
asset for buying it cheap.
E.g. If an individual buys shares in Company B from Company C at a price of ₹1 million and the
FMV of the shares is calculated to be ₹3 million, the individual will be taxed on a notional gain
of ₹2 million.
Implications of Section 56 tax valuations
What is unique about the provisions of Section 56 is that they tax entities that do not seem to
have any obvious 'gain' which is to be taxed. After all, if debt funding by a company is not
taxable in its hands, why should equity funding be? Similarly, until a buyer of shares sells the
same shares, can we say a 'gain' has occurred? Finance and tax professionals alike find the
provisions somewhat counter-intuitive however it seems they are here to stay.
It's also important to note that Section 56, being a section for "miscellaneous income" has the
highest marginal tax rate of 30%++. In case of foreign companies, the applicable tax rate is 40%
++. Capital gains can be charged at 10%++ or 20%++ which is comparatively much more
advantageous.
FMV and tax valuations
There is a recurring reference to fair market value or FMV as can be seen above. What is FMV?
FMV is defined under Income Tax Rule 11UA and Rule 11UAA. These rules specify that tax
valuations be carried out with the following interpretations of FMV:
FMV for sections except 56(2)(viib): FMV is to be calculated for unlisted equity shares using a
modified asset valuation method. This method requires the substitution of book value of certain
assets with their fair value – usually immovable property, shares held, art and jewellery, etc.
Certain accounting assets and liabilities are also to be ignored. Finally the net asset value (pro-
rated to paid-up capital) is the FMV.
FMV for section 56 (2)(viib): FMV for the section relating to fund-raising by a private company
is defined as net asset value or discounted cash flow (DCF) value of the shares of the company.
This is the only instance in which an income approach is permissible in tax valuations.
Other points to note
Tax valuations are usually triggered in fund-raising and when shares are bought/sold below the
FMV. In the majority of transactions for going concerns and profitable businesses, this does not
apply as consideration is usually well above FMV. However in many businesses it may either be
below FMV or close enough to FMV to trigger taxation. FMV also changes depending on the
balance sheet date and may therefore cause a shock post-transaction if significant movements
have occurred.
All in all, it is best to conduct tax valuations while contemplating the transaction or immediately
post-transaction, to understand what the tax implications are. Importantly, CFOs and tax heads
must remember that it is not only the obvious 'gains' that are covered by the Income Tax Act – it
is also the notional and potential gains that are in the tax net.
Taxmann

Meaning of 'sum of money' used in section 56(2)(x)(a)

'Sum of money' means a quantity of money of a specified amount. In CIT v. Kasturi & Sons
Ltd. [1999] 103 Taxman 342 (SC), the Court held that 'When the Legislature has instead of using
any word such as "benefit" used only the term "money", it can refer only to money as understood
in the ordinary common parlance.' The Court ruled that the word "money has to be interpreted
only as actual money or cash and not as any other thing which could be evaluated in terms of
money." The Court further ruled that "money" cannot be interpreted as "money's worth".
In H.H. Sri Rama Verma v. CIT [1991] 187 ITR 308 (SC) observed as under :
"The use of the expression 'any sum' paid under section 80G(2)(a) contemplates payment of an
amount of money. One of the dictionary meanings of the expression 'sum' means any definite
amount of money. The context in which the expression 'sums paid by the assessee' has been used
makes the Legislative intent clear that it refers to amount of money paid by the assessee as
donation.
The plain meaning of the words used in the section does not contemplate donations in kind.
Donations may be made by supplying goods of various kinds including building, vehicle, or any
other tangible property but such donations, though convertible in terms of money, do not fall
within the scope of section 80G(2)(a) entitling an assessee to deduction. Donation of shares of a
company does not amount to payment of any sum or amount though the shares, on their sale,
may be converted into money. But the donation so made does not fall within the ambit of the
aforesaid section."
In ITO v. Komal Kumar Bader [2009] 33 SOT 58 (Jp.), ITAT held that money cannot be
understood in a wider sense to include wealth or "total value of property" as held by the AO. The
ITAT cited with approval the following definition of "money" in Random House Unabridged
Dictionary :

(1) any circulating medium of exchange, including coins, paper money, and demand
deposits.
(2) paper money.
(3) gold, silver, or other metal in pieces of convenient form stamped by public authority and
issued as a medium of exchange and measure of value.
(4) any article or substance used as a medium of exchange, measure of wealth, or means of
payment, as checks on demand deposit or cowrie.
(5) a particular form or denomination of currency.
Relying upon the above dictionary definition and Supreme Court decisions in Kasturi & Sons
Ltd. (Supra) and H.H. Sri Rama Verma (supra), the ITAT held that what is meant by money in
simple sense is that it is a medium of exchange in a particular form or denominated in currency.
It cannot be of the nature where value has to be derived. Thus, the term "sum of money" shall
include cash, cheques, drafts, etc. Money does not include stocks (Shelmer Gilb, In re Eq. Rep
202), jewellery, immovable properties.

Meaning of the word "receives" used in section 56(2)(x)

The word 'receive' is defined by Words and Phrases Legally Defined (Third Edition) as under :

♦ 'Prima facie, as a matter of ordinary English language, I think 'received' means actually
get into their hands.' (Per Harvey J in Pilcher v. Logan (1914) 15 SR (NSW) 24 at 27)
♦ The ordinary meaning of 'receiving' "may be either (a) actually receiving into his
possession and control, or (b) becoming entitled to what has been described as the de
jure receipt of his share - that is to say, to be credited with specific appropriation in
account of the share and the proceeds therefrom. That means it is debitum in praesenti
solvendum in futuro - i.e. presently owing but not payable till a later date"Re Hill,
Hill v. Caile [1948] NZLR 356 at 363, 364, per Flair J.
The Compact Oxford Dictionary gives the following definitions of 'receive'.
Receive

♦ verb 1 be given, presented with, or paid. 2 accept or take delivery of.

From the definition given by Flair J. above, it appears that a receipt of sum of money without
consideration can be by way of crediting the account of the recipient in the books of the giver.
CBDT must clarify whether this is the case.

Whether receipt of gift of Indian millennium deposit certificates issued by SBI along with gift deeds is recei
The ITAT (Mumbai Bench 'A') considered this question in Asstt. CIT v. Anuj Agarwal [2010] 3
taxmann.com 46 (Mum.). In this case, the assessee had received a gift of India Millennium
Deposits Certificate (IMD) certificates issued by State Bank of India. The assessee received the
gift in financial year 2002-03. Gift deed dated 19-7-2002 signed by the donor mentioned the
fact that gift was effected by handing over IMD certificate to the assessee. As per the terms and
conditions of issue of IMD certificates, face value of the certificate together with interest at
8.5% per annum compounded half-yearly was payable on 29-12-2005 to the registered holder
of this certificate. These certificates were capable of being transferred by way of gift. The
Principal amount of this certificate was Rs. 13,50,300. Interest payable on this certificate was
 Rs. 7,09,613. The total maturity value of this certificate was Rs. 20,59,913. The assessee had
received maturity amount on the certificate in the previous year relevant to assessment year
2006-07. The Department sought to tax the principal amount under section 56(2)(vi) of the Act.
The ITAT held that prior to introduction of section 56(2)(vii) by the Finance Act, 2009, w.e.f. 1-
10- 2009, gifts in kind were outside the purview of section 56(2)(v) or (vi) of the Act. The
expression used in section 56(2)(v) and (vi) is 'where any sum of money' exceeding Rs. 25,000
is received by an individual from any person. Since in the present case, what was given without
consideration was only IMD certificates, provisions of section 56(2)(v) or (vi) could not have
been invoked by the Assessing Officer. Thus, receipt of gift of IMD certificates with gift deed
does not amount to receiving sum of money without consideration for the purposes
of section 56(2)(x)(a).
Modes of receipt of sum of money-should be by non-cash mode if it exceeds Rs. 2,00,000 to avoid double wh
Section 56(2)(x)(a) does not stipulate whether sums of money should be received by cash or
account payee cheque/DD or by debit cards or card cards or online transfers. As far
as section 56(2)(x)(a) is concerned sums of money received by whichever mode is taxable if the
sums in aggregate exceed the threshold of Rs. 50000 in a financial year. However, the Finance
Act, 2017 has inserted new section 269ST in the Act containing provisions as regards 'Mode of
undertaking transactions'. Section 269ST which came into force on 1-4-2017 provides that No
person shall receive an amount of two lakh rupees or more—
(a) in aggregate from a person in a day; or
(b) in respect of a single transaction; or
(c) in respect of transactions relating to one event or occasion from a person,
otherwise than by an account payee cheque or an account payee bank draft or use of electronic
clearing system through a bank account:
Question arises what if a huge cash gift of Rs. 5,00,000 is received from a donor and offered to
tax in ITR by donee and tax paid by donee? What if say 5 Rs. 1,00,000 cash gifts are received
from same donor during FY 2017-18 and offered to tax in ITR by donee and tax paid by him?
Would the consequences of penalty u/s 271DA apply in addition to donee? It would appear that,
in addition to tax payable by him, donee would also be liable to penalty u/s 271DA unless the
Central Government exempts cash gifts taxable u/s 56(2)(x) by issuing a notification under
clause (iii) of proviso to section 269ST.
uestion arises what about the above tax-exempt gifts [Items (I) to (IX) above] of money
received in cash? Will section 269ST read with section 271DA apply here also? Of course gifts
mentioned in (V) to (VIII) are more likely to be by way of non-cash modes. However, gifts
in (I) to (IV) above and amounts received on total or partial partition of HUF may be in cash.
Gifts mentioned in Item (II) i.e. on the occasion of the marriage of the individual are usually in
cash received in sealed envelopes. It is quite possible that gifts received in cash in sealed
envelopes from some 100 persons may amount to say Rs. 10,00,000 and no single donor has
given more than Rs. 1,99,000. In such a case, it appears that section 269ST would not kick in as
it does not amount to "receive an amount of three lakh rupees or more….. in respect of
transactions relating to one event or occasion from a person". However, if any money gift
received from a person on occasion of marriage is Rs. 3,00,000 or more, it has to be accepted
by an account payee cheque or account payee bank draft or use of electronic clearing system
through a bank account.
It would appear that section 269ST would appear to tax-exempt cash gifts also unless Central
Government exempts such receipts from section 269ST by issuing notification under proviso
(iii) to section 269ST
Lottery prize - Whether amount or property received without consideration? 33B.2-10
Mr. X purchased a lottery ticket of Rs. 5. He won a prize of Rs. 25,000 on it. His other income
for the previous year is Rs. 1,25,000. His argument is that this is sum of money received without
consideration. He argues as the amount does not exceed Rs. 50,000, the amount is exempt from
tax in terms of section 56(2)(x)(a). He wants to claim a refund of the TDS deducted on his prize
amount. Can he do so?

The contention of X that he received the sum of Rs. 25,000 without consideration is incorrect. In
Sunrise Associates v. Govt. of NCT of Delhi [2006] 5 SCC 603/4 STT 105, the Supreme Court
held that the price paid for lottery ticket is consideration paid for chance to win. Thus, without
paying this consideration, it would not have been possible for X to participate in the draw and he
would not had a chance to win.

In Bonacker et al v. US 62-1 USTC 9180, Mrs. Bonacker attended the National Convention of
National Sales Executives Association with her husband. She had purchased the tickets for
attending the Convention. She won a prize - a Ford automobile at the lucky draw at the
Convention dinner. From the report, it appears that Ford Motor Company had sponsored the
convention and/or the prize. Mrs. Bonacker had testified that she was not aware of the prizes
until she arrived there. She had not attended the Convention or the final dinner that she should
thereby become eligible for the prizes. A question arose whether it was a 'prize' or a 'gift'. His
Honour held that the determination of whether the car was a gift or not is a matter of fact
depending upon all the surrounding circumstances, one of the most important of which was the
intent of the transferee. The subjective knowledge and intent of Mrs. Bonacker although a
relevant factor was not deemed to be a controlling factor. Although there was no direct proof in
the case as to the intention of the Ford Motor Company in giving the gift, the Court inferred from
the facts that the automobile was given either as a part of an advertising promotion, for the
general purpose of obtaining the goodwill of the persons at the convention, or as a contribution
to the overall success of the convention itself. His Honour noted that in any case, 'Ford did not
intend to give it to any person unless that person, as a prior condition, obtained a ticket entitling
her to attend the final dinner of the convention. Mrs. Bonacker satisfied this condition when she
obtained a complete series of tickets at a cost of $20.00, entitling her to participate in all of the
activities of the convention and to receive all of the benefits available, one of which was the
chance to win the automobile. His Honour held that some part of the purchase price was
allocable to this opportunity to win the automobile since 'without payment of this price, this
opportunity - among others - would not have been available'. Thus, prize received under the
lottery ticket (whether, money or money's worth) cannot be brought within the ambit of section
56(2)(x) to the benefit of the purchaser

Money prizes won in contest - Whether sums of money received without consideration?
In Robertson v. US [52-1USTC 9343], the US Supreme Court formulated the following simple
test to determine whether the item given away was a 'prize' or a 'gift': 'What has the taxpayer
done in way of services in order to be eligible for the prize'? In that case, a philanthropist
established a music award offering $25,000, $5,000 and $2,500 for the three best symphonic
works written by native-born composers. The terms of the offer provided that the composition
remained the property of the composer with certain rights being granted to Detroit Orchestra
Inc. Petitioner's symphony won the top prize of $25,000. Mr. Justice Douglas held that, in a
legal sense, payment of a prize to the winner of a contest is 'the discharge of a contractual
obligation'. Further, 'the discharge of legal obligations - the payment for services rendered or
consideration paid pursuant to a contract - is in no sense a gift'.
Amount received in lieu of giving up right to contest will
Amount received by assessee in lieu of giving up right to contest will in out of court settlement
is not money received without consideration and is not taxable under section 56(2)(v)/(vi)/(vii)
- Purveb. A. Poonawalla v. ITO [2011] 10 taxmann.com 221/47 SOT 380 (Mum.).
Money or property gifted HUF to member
In Vineetkumar Raghavjibhai Bhalodia v. ITO [2011] 11 taxmann.com 384/46 SOT 97 (Rajkot)
wherein ITAT held that in the context of section 56(2)(vi) that an HUF is nothing but 'a group of
relatives'. So if an individual receives gifts whether from an individual relative or a group of
relatives, he should be exempt from taxation. The ITAT observed as under:
'… Actually a "Hindu Undivided Family" constitutes all persons lineally descended from a
common ancestor and includes their mothers, wives or widows and unmarried daughters. All
these persons fall in the definition of "relative" as provided in Explanation to clause
(vi) of section 56(2) of the Act. The observation of the CIT(A) that HUF is as good as 'a
body of individuals' and cannot be termed as "relative" is not acceptable. Rather, an HUF is
'a group of relatives'.
Further, from a plain reading of section 56(2)(vi) along with the Explanation to
that section and on understanding the intention of the legislature from the section, we find
that a gift received from "relative", irrespective of whether it is from an individual relative
or from a group of relatives is exempt from tax under the provisions of section 56(2)(vi) of
 the Act as a group of relatives also falls within the Explanation to section 56(2)(vi) of the
Act. It is not expressly defined in the Explanation that the word "relative" represents a
single person. And it is not always necessary that singular remains singular. Sometimes a
singular can mean more than one, as in the case before us. In the case before us the assessee
received gift from his HUF. The word "Hindu Undivided Family", though sounds singular
unit in its form and assessed as such for income-tax purposes, finally at the end a "Hindu
Undivided Family" is made up of "a group of relatives". Thus, in our opinion, a singular
words/words could be read as plural also, according to the circumstance/situation. To quote
an example, the phrase "a lot". Here, the phrase "a lot" remains as such, i.e. plural, in all
circumstances and situations, where in the case of "one of the friends" or "one of the
relatives", the phrase remains singular only as the phrase states so that one amongst the
relatives and at no stretch of imagination it could mean as plural whereas in the phrase "a
lot" the words "a" and "lot" are inseparable and if split apart both give distinctive
numbers, i.e. "a" singular and "lot" plural and whereas when read together, it can only read
as plural in number unlike in the case of "one of the relatives" where "one" is always
singular in number whereas "relatives" is always plural in number, but when read together it
could read as singular in number. Applying this description with the case on hand, we have
already found that though for taxation purpose, an HUF is considered as a single unit, rather,
an HUF is "a group of relatives" as it is formed by the relatives. Therefore, in our considered
view, the "relative" explained in Explanation to section 56(2)(vi) of the Act includes
"relatives" and as the assessee received gift from his "HUF", which is "a group of relatives",
the gift received by the assessee from the HUF should be interpreted to mean that the gift
was received from the "relatives" therefore the same is not taxable under section 56(2)(vi) of
the Act, we hold accordingly.'
The Union Budget 2017 was one of the most anticipated budgets in recent times. Coming on the
back of the demonetisation drive, expectations were high and the Finance Act, 2017 duly
delivered on many aspects. Anti-abuse provisions received a big face lift and provisions were
introduced to incentivise tax-payers to adopt digital and banking channels for transactions. One
of such anti-abuse provisions introduced is Sec 50CA. 50CA was introduced in addition to a few
anti-abuse measures already in place with respect to curbing the practise of avoiding tax through
transfer of shares and will be in effect for any transfer of unquoted shares after 1st April, 2017.
The section provides that where consideration for transfer of share of a company (other than
quoted share) is less than the FMV of such shares determined in accordance with the manner to
be prescribed, the FMV shall be deemed to be the full value of consideration for computing
capital gains. Why this provision for Unquoted Shares A quoted share is one where “the share is
quoted on any recognised stock exchange with regularity from time to time, where the quotation
of such share is based on current transaction made in the ordinary course of business”. A value of
a share is reflective of the net book value and fair market value of the assets, the potential of the
company and the products and lineage of the company. Therefore, where a share is quoted, the
quoted value on the stock exchange will be the fair market value of the share with little scope of
manipulation. The value, therefore, taken as sale consideration u/s 48 for the purpose of
computation of capital gains, will be this fair market value. This benefit however, in unavailable
to unquoted shares. Unlike quoted shares, which are freely traded on the stock exchange,
unquoted shares are largely unregulated and there existed no restriction on the pricing and
valuation of these shares. This led to utilisation of the provisions to abusive practices where
companies attempted to avoid capital gains tax on transfer of shares, by valuing the shares very
low and escaping tax. Illustration of what was being done Company X & Co Pvt Ltd., holds
multiple assets in the form of land and buildings worth Rs. 500 crores. The company has a Share
Capital of Rs.10,00,000 – 10,000 shares at Rs.100 Face Value per share. The shareholder sells
the share for Rs.10 per share to the buyer. The underlying value of the shares in the company are
significantly higher than the face value, due to the assets which are present in the company and
their fair market value. Here, the seller/transferor of the shares, has sold the shares at a nominal
value of Rs.10/-, and the buyer gets to enjoy assets worth Rs.500 crores at that rate. Given the
sham nature of the transaction and the understatement of value, significant taxes in the form of
capital gains are avoided and in some cases, the seller even enjoys the benefit of a capital loss
that can be set-off against other capital gain incomes earned. 50CA is the Guideline Value for
Shares Section 50C was introduced by Finance Act 2003 and was a game-changing provision.
Where an immoveable property was transferred for a value less than the value adopted or
assessable by any authority of the State Government, i.e. Stamp Value/Guideline Value, the, such
value will be adopted for the purposes of Sec 48, while computing the capital gains. As per the
Act, income chargeable under the head 'Capital gains' is computed by taking into account the
amount of full value of consideration received or accrued on transfer of a capital asset. In order
to ensure that the full value of consideration is not understated, the Act stipula Section 56(2)(vii)
and 56(2)(viia) provided that where any person received any shares without adequate
consideration for an amount exceeding Rs.50,000/-, then such amount will be brought to tax as
income from other sources. Sec 56(2)(vii) and (viia) will no longer be applicable after 1st April,
2017. Instead, a new section Sec 56(2)(x) has not been introduced. This section provides for
taxability in the hands of the purchaser of shares2, if the purchase is made without consideration
or for consideration less than the FMV of such property. Further, in line with the extant provision
of the Act, this provision would only trigger if the difference between the consideration paid and
the FMV exceeds INR 50,000. With the introduction of this clause, the scope of the extant
provision has been expanded to all the tax payers. In substance, Sec. 56(2)(vii) and (viia) are still
enshrined in Sec 56(2)(x). However, the important point to note is that the income is taxed twice,
once in the hand of the seller and the second time in the hands of the buyer. This is demonstrated
in the illustration below. Illustration A acquired 100,000 shares of Winners Pvt Ltd. for Rs.5 per
share. The shares were sold to B at Rs.8 per share. The Fair Market Value on date of the transfer
was Rs.10/- per share. The following will be the impact of both Sec 50CA and Sec 56; under old
provisions and as per the amended provisions: Old Provisions Amended Provisions Details
Transfer of shares Sec 56(2) (vii) Sec 50CA Sec 56(2)(x) Computation of Capital Gains –
Seller/Transferor is taxed Sale consideration Rs.8,00,000 Rs.10,00,0 00 Less: Cost of acquisition
(Rs.5,00,00 0) (Rs.5,00,0 00) Capital Gains Rs.3,00,00 0 Rs.5,00,0 00 Income from Other
Sources – Buyer/Transferee is taxed FMV of shares (Rs.10 * 1,00,000 shares) Rs.10,00,0 00
Rs.10,00, 000 Less: Actual cost of acquisition (Rs.8 * 1,00,000 shares) (Rs.8,00,0 00) (Rs.8,00,0
00) Income from other sources Rs.2,00,0 00 Rs.2,00,0 00 As it can be seen, the overall tax effect
of both Buyer and Seller is higher under the new provisions by Rs.2,00,000/-. Accordingly, the
amount of INR 200,000 would have been taxed in the hands of the transferee under the extant
provisions. Similar provision are stipulated under the proposed section 56(2)(x) of the Act, and
consequentially the clause (viia) of section 56(2) of the Act is proposed to be made inapplicable
with effect from 1 April 2017. Therefore, the amount of INR 200,000 would be taxed in the
hands of transferee under the proposed provisions as well. From the above example, it may be
seen as per the extant provisions of the Act, the amount of INR 200,000 was being taxed in the
hands of transferee. However, the section 50CA proposes to tax the amount of INR 200,000 in
the hands of transferor. Consequently, the amount of INR 200,000 is being taxed in the hands
transferor as well as transferee. Wrap up Point: The Finance Act, 2017 has introduced some
excellent provisions to curb black money and crack down on tax evaders. The measure to curb
transfer of shares at value less than FMV has been introduced with the same intent. However,
due to the double taxation effect, Sec 50CA and Sec 56(2)(x) provisions, while are anti abusive,
are also difficult for tax-payers to bear. Further, the proposed rules for valuing the Fair Market
Value of unquoted equity shares of investment holding companies wherein downstream
investments would now need to be valued applying the proposed valuation approach, as against
valued at cost currently. The similar impact would be there on mere property holding companies
where the stamp duty value of property would be considered now. This is an excellent move at
curbing the practice of transferring shares of companies at nominal value, when the have assets
of substantial value and their underlying value of the share is much higher than the carrying
value.
IRS PAPER
The case of Vaani Estates (P.) Ltd. v. ITO [2018] 98 taxmann.com 92 (Chennai - Trib.)

2.1 Facts of the case - The assessee was a private limited company engaged in real estate
business, which filed its return of income for the assessment year 2014-15, declaring loss of Rs.
4,40,920. After scrutiny the AO made addition of Rs. 23,31,68,600 towards 'Income from other
sources' invoking the provisions of Section 56(2)(viib) of the Act.

The AO said that assessee-company had issued 10,100 equity shares having face value of Rs. 10
each at a premium of Rs. 23,086 to one of the existing shareholders. On inquiring, it was
explained by taxpayer that the assessee-company had acquired land for a consideration of Rs.
23,09,57,869 and, therefore, the fair market value per equity share of the company was Rs.
23,096. However, the assessee-company had computed net worth of equity share, after taking
into account the value of the new asset acquired which was subsequent to the receipt of share
application money from Mrs. Sasikala Raghupathy, and the AO opined that the assessee-
company had received excess price/share premium for the shares allotted to Mrs. Sasikala
Raghupathy over and above the face value of shares which worked out to Rs. 23,31,68,600 (i.e.,
23,086 * 10,100). Accordingly the AO invoking the provisions of Section 56(2)(viib), added the
amount of Rs. 23,31,68,600 to the income of the assessee.

2.2 What the assessee stated - Before the CIT (A), the AR made the following submissions:—

"The Appellant-Company had only two shareholders, viz, Mrs. Sasikala Raghupathy and her
husband Mr. B. G. Raghupathy (each holding 5,000 shares). On passing away of E.G.
Raghupathy, his 5,000 shares devolved on her daughter, Mrs. Vani Raghupathy. Therefore, Mrs.
Sasikala Raghupathy and her daughter, Mrs. Vani Raghupathy were holding 5,000 shares each.

The Company proposed to acquire immovable property, viz, the land. The value of the land was
approximately Rs. 23.09 crores. Accordingly, Mrs. Sasikala Raghupathy who had the funds,
brought in money of Rs. 23.32 crores. She was allotted 10,100 shares with a share premium of
Rs. 23.31 crores. The Assessing Officer brought to tax, in the hands of the Company, Rs. 23.31
crores under Section 56(2)(viib).

Section 56(2)(viib) was introduced by the Finance Act, 2012. The purpose of introduction
of Section 56(2)(viib), as explained by the Finance Minister was to deter generation and use of
unaccounted money.

But in the instant case, the entire share holding of the Company was held by the mother and the
daughter. The Company wanted funds for acquiring landed property. As only mother had the
necessary funds, she brought in requisite amount to acquire the property.

It should also be understood that the purpose of Section is to tax undue benefit given to the
existing shareholders by way of introducing large amount of share premium and thus, avoiding
taxation under Section 56(2)(x). However, in this case benefit went to daughter of the
shareholders, who fell within the exempted category of relatives under section 56(2)(x). Any
benefit granted by mother to daughter is not taxable under Section 56(2)(x).

Again, Mother could have gifted 50% of the amount to the daughter, which was not taxable
u/s. 56(2)(x). Both could have invested equal amount in the Company, on the same terms and
conditions. Even then the company would be assessed to tax u/s. 56(2)(viib). That is to say, even
if all the existing shareholders contribute additional equity in proportion of their shareholding
(Rights issue) for the business of the Company, and if the shares are allotted at a premium, the
Company will be taxed u/s. 56(2)(viib). This would be against the purpose of introduction of
the section.

A penal section should be interpreted in a harmonious manner to achieve the purpose for which it
was introduced. It cannot be applied to penalize a genuine transaction.

2.3 What the revenue stated - The CIT(A) confirmed the order of the AO by observing as under:
—
As the purchase of property had happened subsequent to the allotment of shares at premium, it
was not relevant in deciding whether the share premium received was liable for taxation
under 56(2)(viib)?

The section is 'absolute in its wording and does not provide for any exceptions other than the
ones specifically given. It further refers to the valuation of unquoted shares under Rule 11UA,
whereas the assessee had not claimed being specifically covered by any futuristic method of
valuation, like the discounted cash flow. The Assessing Officer had taken the valuation at NAV,
presumed to be adopted by assessee and considered the entire share premium as being excessive
and liable for taxation u/s. 56(2)(viib).

Regarding the plea that beneficial transfer from one shareholder to the other shareholder was
only 25% of the shareholding and, as such, the taxation of share premium had also to be
restricted to only 25% of the total premium received, Section 56(2)(viib) does not provide any
limitation from taxation of share premium which is in excess of the fair market value of the
shares.

Moreover, the section has not provided for limiting the amounts attracted u/s. 56(2)(viib) for
taxation by considering the benefit which accrues to the existing set of shareholders on account
of share allotment to new set of shareholders. All grounds taken were rejected, the CIT said.

2.4 What the Tribunal held - The Tribunal, after perusal of the submissions made by assessee
before the Revenue Authorities, the Finance Minister's speech of Finance Bill 2012 and the
Finance Bill 2012, Bill No.11 of 2012 [As introduced in Lok Sabha on 16th March 2012] found
merits in the submissions of the AR.

Section 56(2)(viib) applies where a company, not being a company in which the public are
substantially interested, receives, in any previous year, from any person being a resident, any
consideration for issue of shares, in such a case if the consideration received for issue of shares
exceeds the face value of such shares, the aggregate consideration received for such shares as
exceeds the fair market value of the shares shall be chargeable to income-tax under the head
"Income from other sources". Further, it also provides the company an opportunity to
substantiate its claim regarding the fair market value.

It was apparent that, though Mrs. Sasikala Raghupathy had introduced cash into the assessee-
company amounting to Rs. 23.31 crores for allotment of shares at premium of Rs. 23,096 per
share when the intrinsic value of the share was only Rs. 10 per share which was the face value of
the shares, the benefit of such investment at an unrealistic share premium only passed on to her
daughter because there were only two shareholders in the assessee-company, i.e., Mrs. Sasikala
Raghupathy and her daughter Mrs. Vaani Raghupathy at that point of time.

Further, Section 56(2)(viib) was introduced only to curb generation and use of unaccounted
money. In the absence of the provisions of Section 56(2)(viia) & Section 56(2)(viib) of the Act it
was possible for any company, either closely held or otherwise to introduce unaccounted money
as investment in equity share of the company with inflated share premium through a deploy as an
investor.

Here the investors source of investment was genuine and not in dispute. The only other lone
shareholder of the assessee-company was the daughter of late Mr. B.G. Raghupathy and Mrs.
Sasikala Raghupathy, who was the new entrant in the business of her parents with no scope of
possessing undisclosed cash.

Thus, there was no possibility of generation and use of unaccounted money resulting from the
transaction of infusing cash by Mrs. Sasikala into the assessee-company in the form of equity
share premium. Moreover, when the whole transaction was viewed by lifting the corporate veil
of assessee-company, it was apparent that 24.88% [Mrs. Sasikala Raghupathy's percentage of
shareholding : 15,100 (total number of shares held *100/20,100 (Total number of shares allotted)
= 75.12% and Mrs. Vaani Raghupathy's percentage of shareholding : 5,000 (total number of
shares held) * 100/20,100 (Total number of shares allotted) = 24.88%] out of the benefit arising
out of the introduction of cash in the form of equity share with premium only benefited from
Mrs. Sasikala Raghupathy to Mrs. Vaani Raghupathy, i.e., from mother to daughter.

Further, it is pertinent to mention that by virtue of the provisions of Section 56(2)(vi) & (x) of the
Act when gift is bestowed by mother to daughter, it is not taxable. Thus, when the provisions
of Section 56(2)(vi), (viib) & (x) of the Act, are interpreted in a harmonious manner lifting the
corporate veil of the assessee-company, it becomes abundantly clear that Section 56(2)(viib) 'has
no implication' in the case of the assessee-company, more-so keeping in view of the speech
delivered by the Finance Minister. In the instant case, the benefit of infusing cash into the
assessee-company by way of equity share with premium by the mother would not benefit any
other shareholders inducted in the company in future because the shares will have to be allotted
on the basis of the intrinsic value of the shares of the assessee-company otherwise, at that point
of time, Section 56(2)(viib) would be instantly attracted. The Tribunal was also reminded of the
principles of harmonious construction explained by Crawford in Statutory Construction "Hence
the Court should, when it seeks the legislative intent, construe all the constituent parts of the
statute together and seek to ascertain the legislative intention from the whole Act, considering
every provision thereof in the light of the general purpose and object of the Act itself and
endeavouring to make every part effective, harmonise and sensible". Further, mischief of rule of
interpretation also propagates that where a statute has been passed to remedy a weakness, in law,
the interpretation which will correct that weakness is the one to be adopted.

It should be also kept in mind that provisions of Section 56(2)(viib) of the Act create a deeming
fiction and while giving effect to such legal fictions all facts and circumstances incidental thereto
and inevitable corollaries thereof have to be assumed. The Kolkata High Court in the case
of M.D Jindal v. CIT [1986] 28 Taxman 509/[1987] 164 ITR 28 (Cal.) held that "legal fictions
are created only for a definite purpose and they are limited to the purpose for which they are
created and should not be extended beyond the legitimate field. But the legal fiction has to be
carried to its logical conclusion within the framework of the purpose for which it is created."
Further, it was apparent from the Finance Minister's speech that the provisions of Section 56(2)
(viib) had been enacted to deter the generation and use of unaccounted money. In a decision of
the Hon'ble Apex Court, regarding case of Allied Motors v. CIT [1997] 91 Taxman 205/224 ITR
677 (SC), it was held that the Finance Minister's Budget speech explaining the provisions are
relevant in construing the provisions. Moreover, in the decision rendered by the Jurisdictional
Madras High Court in the case of CIT v. Kay Arr Enterprises [2008] 299 ITR 348 (Mad.) and in
the decision of the Karnataka High Court in case of CIT v. R. Nagaraja Rao [2012] 21
taxmann.com 101/207 Taxman 236/[2013] 352 ITR 565 it has been categorically held that
"where there are transactions involving family arrangement with respect to transfer of shares, the
corporate veil of the company has to be lifted and inferred that there is no transfer of shares and,
accordingly, capital gain tax is not exigible." From the above it is apparent that even when there
are transfer of shares physically, in the event of family arrangements, the Hon'ble High Courts
have held that the entire transaction has to be viewed by lifting the corporate veil and treat the
issue as if there is no transfer of shares and, hence, capital gains tax is not attracted. Similarly,
the Chennai Tribunal upheld the view that in this case also the corporate veil is required to be
lifted and thereafter the transaction has to be viewed in the light of the relevant provisions of the
Act.

Bearing in mind the facts of the case, the decision of the higher Judiciary Authorities cited supra
and the legal principles discussed the Chennai Tribunal pronounced the considered view that
provisions of Section 56(2)(viib) of the Act, could not be invoked in the case of the assessee-
company because by virtue of cash being brought into the assessee-company by Mrs. Sasikala
Raghupathy for allotment of equity shares with unrealistic premium the benefit had only passed
on to her daughter, Mrs. Vani Raghupathy and there was no scope in the Act to tax when cash or
asset was transferred by a mother to her daughter. Hence, the Tribunal directed the AO to delete
the addition made by invoking the provisions of Section 56(2)(viib) of the Act in the case of the
assessee-company.

In the result, appeal of the assessee was allowed.

DIGVIJAY
Exclusions of tax neutral transfers from income from other sources [Section 56(2)(x)]
Fourth proviso to section 56(2)(x) provides for certain exceptions from applicability of the
said section. Clause (IX) to the said proviso states that section 56(2)(x) is not applicable to
certain transfers exempt under section 47.
The scope of this exception is extended with effect from assessment year 2019-20 to provide
that section 56(2)(x) will not apply to transfers exempt under section 47(iv) or section 47(v).
 Section 47(iv) provides that transfer of a capital asset by a subsidiary company is exempt :

(a) if the parent company or its nominees hold the whole of the share capital of the
subsidiary company, and
(b) the subsidiary company is an Indian Company.
Section 47(v) provides for exemption of any transfer of a capital asset by a subsidiary company
to the holding company if the :

(a) whole of the share capital of the subsidiary company is held by the holding company,
and
(b) the holding company is an Indian company.
The amendment exempts transfer of capital asset but does not apply to stock-in-trade.
8.2-1 Section 47A v. Section 56(2)(x)
Section 47A provides for taxation in the hands of transferor company if the transferee company
converts the capital asset to stock-in-trade or the trans-feror company ceases to hold the whole of
share capital of the transferee. It appears that even if section 47A is triggered, the transferee
company is not taxed under section 56(2)(x).
8.2-2 Section 2(22)(a) v. Section 56(2)(x)
Section 2(22)(a) provides that any distribution by a company shall be regarded as dividend if
such distribution is of accumulated profits and it entails the release by the company to its
shareholders of any asset of the company. This aspect has to be borne in mind while making a
distribution from a subsidiary company to holding company. While the holding company may
not be taxed under section 56(2)(x), the distribution could be taxed under section 2(22)(a).

19.8 Whether Section 68 or Section 56(2)(x) or both shall apply to taxation of gifts
Section 68 of the Act has always been invoked against bogus gifts in the hands of recipient. The
Finance (No. 2) Act, 2004, introduced the concept of donee-based taxation of gifts by inserting
new clause (v) in section 56(2) with effect from 1-9-2004.
The Finance Minister, in his Budget Speech of 2004 explained that the objects of donee-based
gift tax introduced to plug a loophole to prevent money laundering that was in vogue after
abolition of gift tax in 1997. CBDT's Circular No. 5/2005, dated 15-7-2005 explains the
rationale of new clause (v) as aimed at curbing "bogus capital-building and money-
laundering". Again, in the Explanatory Memorandum to Finance Bill, 2010, the objects behind
donee-based transactions have been explained as "introduced as a counter evasion mechanism
to prevent laundering of unaccounted income under the garb of gifts, particularly after abolition
of the Gift Tax Act."
 In Chandrakant H. Shah v. ITO [2009] 28 SOT 315 (Mum.), the Tribunal held that
section 56(2)(v) was introduced to bring bogus gifts to tax. The Tribunal observed as under:
Section 68 Section 56(2)(x))

Applicable to all Applicable to all assessees

assessees

No monetary Gifts above monetary threshold taxable

threshold/exemptio
n

No exemption to Gifts from specified relatives or on occasions of marriage exempt

gifts received from
relatives or gifts
received on
occasions of
marriage

Pre-condition for Applicable irrespective of whether assessee maintains books or not and irrespective of whet
attracting section 68
is that assessee
maintains books of
account and credits
the gift in his books

Income treated as Income will be taxed at applicable tax slab

undisclosed income
under section 68 are
taxable at a flat
effective rate of
77.25%1 under
section 115BBE(1)

"…………….The Finance Minister has also emphasized on the fact of a loophole

existing due to abolition of the Gift Tax Act, 1958, and, thereafter, words 'money
laundering' have been used in his speech, hence, the intention is only to prevent money
laundering by way of bogus gifts. The Hon'ble Finance Minister has made this intention
clear by referring to the Gift Tax Act, 1958, and by adding exception for gift received from
relatives on the occasion of marriage etc. It is also noteworthy that like gift tax, the basic
exemption limit has also been prescribed in the section and various exceptions provided in
section 56(2)(v) of the Act which were also existing in the like fashion in the erstwhile Gift
 Tax Act, 1958, and this fact also leads to a conclusion that only bogus gifts are also brought
to tax under this provision…………Thus, in view of above discussion, we are of the view
that this provision applies to the transactions where undisclosed/unaccounted income of a
person is brought in his hand by way of purported gifts."
Since sections 68 and 56(2)(x) both target bogus gifts, a question arises as to which provisions
will apply to taxation of gifts. Moreover, the tax implications differ between section 68 on one
hand and section 56(2)(x) on the other.
It would be instructive to compare section 56(2)(x) with section 68 as these are all anti-abuse
provisions to prevent money laundering in the garb of gifts:
In Asstt. CIT v. Lucky Pamnani [2011] 129 ITD 489 (Mum.), the ITAT held that reference to
the bona fides of gift is unnecessary for consideration, while applying section 56(2)(v) of the
Act. The ITAT observed as under:

Two funny arguments

♦ The first hilarious argument advanced by income-tax authorities is that relatives are
exempt from taxation only under Section 56(2)(v), 56(2)(vi) and 56(2)(vii), and not
under section56(2)(viib) of the Act. The CIT said: "It is specifically noted that the
liability for taxation u/s. 56(2)(viib) has not been made specifically exempt when the
beneficial transfer is between 'relatives'. In view of the same, the submissions made by
the assessee for being excluded from the liability for taxation u/s. 56(2)(viib) is
rejected." There is nothing in the Act that says that 'relatives' under Section 56(2)(viib)
are different from 'relatives' mentioned elsewhere. Also, would 'relatives' mentioned
in Section 56(2)(viib) not come under Section 56(2)(vii), the parent clause?
♦ The second amusing argument is that a company is not capable of receiving gift, as it
does not have feelings like love and affection. But the tax authorities themselves say that
the assessee presumed the beneficial transfer from one person/shareholder to the other
person/shareholder ignoring the existence of the third person, which is the company
receiving the share premium. The authorities go on to say that company is by itself a
person and is liable and assessed for taxation. The receipt in excess of FMV is received
by the company and not by the shareholders. The benefit accrues to the company and
not to the individual. Hence, the tax authorities are admitting that company is a person,
capable of love and affection. As it is, in Redington (India) Ltd. v. Jt. CIT [2014] 49
taxmann.com 146 (Chennai - Trib.) and D P World (P.) Ltd. v. Dy. CIT [2012] 26
taxmann.com 163/140 ITD 694 (Mum. - Trib.), it was held that a company is capable of
getting gifts. It was said as 'gift' is not defined, Section 5 of the Gift Tax Act and the
Transfer of Property Act (TPA) have to be followed. The Gift Tax provision says that
gift can be made to anyone, including a company. In TPA there does not seem to be any
 restriction on the corporate transfer of shares by way of gift, provided it is made
voluntarily and without consideration. In other words, there is no requirement that a
'gift' can be made only between natural persons out of natural love and affection, which
means that as long as a donor-company is permitted by its Articles of Association to
make a 'gift', it can do so. Sec 82 of the Companies Act, 1956 also provides that shares
in a company constitute movable property transferable in the manner provided by its
Articles of Association.
Mrintunjay paper
Valuation of Shares is not a science and hence determining the fair market value (FMV) of shares
can be challenging particularly in case of unquoted equity shares. To deal with this, the Income-
tax Department had prescribed a specific formula based on “Net Asset Value Approach” under
rule 11UA of the Income Tax Rules, 1962. However, the said formula took into account the book
value of the asset rather than current market value, or FMV. Recently, the Finance Act, 2017
inserted Section 56(2) (x) so as to widen the scope of taxability of receipt of sum of money or
property without/inadequate consideration. The latest in the series of Specific Anti-Avoidance
Provisions (‘SAAR’) is section 50CA as introduced by the Finance Act, 2017. This amendment
has been introduced for the purpose of taxing the “indirect” sale of immovable property.
Considering the context and objective of section 56(2)(x) and section 50CA, the CBDT had
come out with Draft Rules earlier ( May 2017). It suggested amendment in the method of
valuation of unquoted equity share by taking into account the FMV of jewellery, artistic work,
shares & securities and stamp duty value in case of immovable property and book value for the
rest of the assets. After considering the comments and suggestion, recently, the CBDT has
notified final rules on 12 July 2017 which is largely in line with the draft rules. The Central
Board of Direct Taxes (‘CBDT’) has, vide Notification No. 620 dated 12.07.2017, notified the
muchawaited amended Rule-11UA providing for rules for valuation of unquoted equity shares
relevant for section 56(2)(x) and also, inserted new Rule-11UAA providing for rules for
determination of Fair Market Value (‘FMV’) for unquoted shares relevant for section 50CA of
the Income tax Act, 1961. The aforesaid notified rules are broadly inline with the draft rules
issued by CBDT in May, 2017 for the Public Comments. The notified rules have undoubtedly
provided the muchneeded guidance for the taxpayers with respect to valuation of unquoted
equity shares yet certain issues still remain unanswered in these Rules as highlighted infra.\
1. Bhoruka Engineering Inds. Ltd. Vs. DCIT [2013] 36 taxmann.com 82 (Karnataka High Court]
In this case, Revenue contended that transaction of sale of shares was a colourable device and
virtually immovable property had been transferred. While rejecting such argument the High
Court observed as follows: “The assessee by resorting to such a tax planning has taken advantage
of the benefit of the law or the loopholes in the law, which had ensured to his benefit. After
seeing how this loophole has been exploited within four corners of the law, it is open to the
Parliament to amend the law plugging the loophole.”
2. DCIT vs. Maya Appliances (P.) Ltd [2017] 82 taxmann.com 447 (Chennai - Trib.) In this case,
according to Revenue, the assessee sold the actual land and building in the guise of sale of shares
and thus the provisions of the section 50C is applicable. However, the Tribunal declined to adopt
this argument and held that no question of invoking the provisions of the section 50C of the Act
as there is no direct transfer of land or building or both.
3. Medplus Health Services P. Ltd vs. ITO [ITA.No.871/Hyd/2015] dated 8th March 2016 In this
case, the Revenue adopted the market value of unquoted equity shares ignoring the valuation
methodology given in Rule 11 UA as it was based on Book Value of the assets. The Tribunal held
that “A.O. has to compute the fair market value in accordance with the prescribed method but
cannot adopt the market value as fair market value under section 56(2)(viia) of the Act. The
legislature in its wisdom has also given a formulae for computation of the fair market value
which cannot be ignored by the authorities below.”
Understanding the provisions of Section 50CA
Prior to introduction of section 50CA, where shares were sold by the assessee for a
consideration, which is not in conformity with the fair-market value of the shares, there was no
mechanism available under the Act to substitute the full value of consideration as disclosed by
the assessee by any other value, for the purposes of computation of capital gains. Section 50C
dealt with transfer of capital asset being land or buildings or both, which is not applicable in case
of shares. To plug this loophole section 50CA was introduced.
Applicable to all assessee( Resident, Non-resident, Related and unrelated entity)
Applies to all shares whether equity or preference.
Unquoted Shares should be capital asset
Not applicable with respect to gains from transfer of an interest in a partnership, trust where the
propertyof such entities consists, directly or indirectly of immovable property
May cover even some quoted shares based on the definition of “quoted share”
Where unquoted equity shares are contributed by a partner to a firm, the question will arise
whether the provisions of section 50CA would override section 45(3). In this respect one may
take guidance from the decision in the case of Canoro Resources Ltd., In re [2009] 180 Taxman
220 (AAR) and decision in the case of Carlton Hotel (P.) Ltd. v. Asstt. CIT [2010] 35 SOT 26
(Lucknow Tribunal)
No tolerance band provided. Thus, FMV as per the new formula method will be taken as full
value of consideration, even if difference in FMV and the sale consideration is marginal.
In case of sale consideration being less than FMV, the seller will be taxed under section 50CA
on the ground that he has not declared true consideration. On the other hand, the buyer will be
taxed under section 56(2)(x), on the ground that he has understated the purchase consideration.
Comparative Review 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 there under 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. The 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 01 April, 2017, relaxation
should have been provided to transactions entered between 01 April, 2017 and 12 July, 2017.
Conclusion The new method of calculation of FMV of unquoted equity shares is based on
adjusted Net Asset value Method with certain assets on FMV and remaining assets based on
book value. Thus, now one will have to take into account the FMV of jewellery, artistic work,
shares & securities and stamp duty value in case of immovable property. Where value of
unquoted equity shares are mainly derived from intangibles assets such as goodwill, trademark or
other intangible assets, this approach of valuation will not reflect the true value of the shares of
the company. The prescribed method of valuation fails to give weightage to the fact as to
whether shares being subject matter of transfer are of minority interest or majority interest.
Normally, asset values are out of the reach of the minority shareholder. The prescribed method
of valuation is specific for section 50CA and section 56(2)(x) and cannot be applied in other
sections even though FMV is a term which has been used various places in the Act. In case of
non-resident, three could be chances of conflict between normal provisions i.e. section 50CA and
section 56(2) (x) and the provisions of transfer pricing. There could be difficulty at the time of
withholding tax. Suppose a non-resident seller transfers certain unquoted equity shares to a
resident at Rs. 100 per share whereas the FMV of such share as per new valuation method is Rs.
500 per share. Assuming that cost of share acquired by a nonresident is Rs. 50 per share, the
capital gain would be Rs. 50 per share (if actual sale consideration is considered) or Rs. 450 per
share (if FMV of share is considered). In this respect, it is as yet unclear whether resident payer
shall withhold tax under section 195 on Rs. 50 or Rs. 450. Issue of shares at premium wherein
the provisions of section 56(2)(viib) is applicable, the tax authority is already empowered to
consider the market Value of underlying assets including Intangible assets.
KEY TAKEAWAYS • The notification ensures that value of unquoted shares of a company are
based on fair value of underlying asset. By applying both Sec. 50CA and Sec. 56(2)(x) in respect
of transfer of unquoted shares for a consideration below the FMV, the same would lead to double
taxation as under - - In the hands of transferor [Sec. 50CA] – FMV to be taken as full value of
consideration for computing Capital Gains where transfer is made without consideration or for
inadequate consideration - In the hands of transferee [Sec. 56(2)(x)] - Difference between FMV
and consideration is taxable as IOS. • In the draft notification, for the purpose of Sec. 50CA,
reference was made to Rule 11UA(1)(c)(b) for valuation of unquoted shares. However, sub-
clause (b) of Rule 11UA(1)(c) only covers method of valuation of unquoted ‘equity shares’. In
the final notification, it has been clarified that valuation of unquoted shares shall be done as
prescribed in sub-clause (b) for unquoted ‘equity shares’ and sub-clause (c) for unquoted
‘preference shares’. • Further, in the final notification, CBDT has clarified that for purpose of
Sec. 50CA, valuation date shall be the date on which the capital asset (unquoted shares) is
transferred. • At the outset, the final rules are fairly straight forward and easy to apply. However,
given that the shares and securities held as investments also have to be valued at FMV, certain
challenges may arise while valuing the FMV of the shares and securities in cases of cross
holding and circular chain holding.
http://journal.lawmantra.co.in/wp-content/uploads/2017/08/6-1.pdf
Article by Malay Damania
Damania & Varaiya

When an owner of Unquoted share ("Shares") in a Company transfers the shares to any person,
he is required to pay Capital Gain tax on the difference between the sale consideration received
by him and the cost of acquisition of such shares (or the inflation indexed cost, wherever
applicable).

It is important to check if the "Sale consideration" that he receives from the buyer is at least
equal to or more than the "Fair Market Value" ("FMV") as defined under Rule 11UA of The
Income Tax Rules, of the shares sought to be transferred.
As defined under Rule 11UA, the fair market value of unquoted equity shares shall be the
value, on the valuation date, of such unquoted equity shares as determined in the following
manner under (a) or (b), at the option of the assessee, namely; -

Option (a):

The fair market value of unquoted equity shares shall be calculated simply by ascertaining "Book
value of Assets (Less) Book value of Liabilities."

 For ascertaining the book value of assets, following amounts shall be excluded:

o Advance Tax, Tax deduction or collection at source or any amount of tax

paid as reduced by refund claimed under the Income Tax Act.

o any unamortized amount of deferred expenditure which does not represent

the value of any asset.

 For ascertaining the book value of liabilities, following amounts shall be

excluded:

o the paid-up capital in respect of equity shares;

o the amount set apart for payment of dividends on preference or equity

shares

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

o any amount representing provision for taxation, other than amount of tax
paid as reduced by the amount of tax claimed as refund

o any amount representing provisions made for meeting liabilities, other

than ascertained liabilities;

o any amount representing contingent liabilities other than arrears of

dividends payable in respect of cumulative preference shares.

Option (b):

The fair market value of the unquoted equity shares as determined by a Merchant B anker as
per Discounted Free Cash Flow Method. Earlier, a Chartered Accountant was also permitted to
determine the FMV of such equity shares. However, with effect from 24th May 2018, this right
of Chartered Accountant is taken away and therefore only Merchant Banker is authorised to
determine the FMV of such equity shares.

If the transaction of transfer of shares takes place at a price which is less than the FMV, there is
a tax impact both on buyer of the shares as well as the seller. The legislation has made an attempt
to In order to ensure the full consideration is not understated in case of transfer of unlisted
shares, section 50CA

Impact of Tax on Seller – Section 50CA:

If the seller receives sale consideration on sale/transfer of unquoted equity shares which is less
than the FMV of such shares, the FMV of such shares shall be deemed to be the Sale
consideration received or accrued on such transfer of shares. Therefore, while computing the
Capital Gain on transfer of shares, FMV of share will replace the actual sale consideration on
transfer of such shares. The seller, in such case, will have to pay Capital Gain tax on difference
between FMV of the shares and cost price (or the inflation indexed cost price, as the case may
be) of such shares.

Impact of Tax on Buyer – Section 56(2)(x):

If the buyer acquires unquoted equity shares from a seller which is less than the FMV of such
shares, the difference between the FMV of the shares and actual price paid by the buyer (in so
much as it exceeds Rs. 50,000/-) will be taxable in the hands of the buyer under the hear "Income
from Other Sources."

It is important to note here that both these sections are applicable only when the seller or the
buyer, in respective cases, holds the shares as Capital Asset ie. As Investment. This is not
applicable when the shares are held as Stock in Trade.

Any such shares received (by the buyer) under the following circumstances would
be outside the ambit of section 56(2)(x) -

i. from any relative; or

ii. on the occasion of the marriage of the individual; or

iii. under a will or by way of inheritance; or

iv. in contemplation of death of the payer or donor; or

v. from any local authority; or

 vi. from any trust or institution referred to in section 10(23C); or

vii. from any trust or institution registered under section 12AA; or

viii. by way of transaction not regarded as transfer under specific circumstances as

stated under Section 47; or

ix. from an individual by a trust created solely for the benefit of relative of the
individual.

Section 49(4) – diluting impact on buyer:

In the event when under section 56(2)(x), the buyer is charged to tax on the difference between
the FMP of the shares and the actual price paid by the buyer, Section 49(4) comes to the rescue
of such buyers. According to this section, whenever this buyer sells these shares, the cost of
acquisition will be taken to be value which has been considered for the purpose of Section 56(2)
(x). Thus, the buyer will be saved from double taxation on the differential amount.

Interplay between section 50CA & section 56(2)(x)

Example 1: -

Buyer: - A Seller: - B
A purchased 100 shares of unquoted company from B @ Rs.600/- per share. Thus, total
consideration is Rs. 60,000/-. B had acquired these shares @ Rs. 500/- per share i.e. Total cost of
Rs. 50,000/-. Current FMV is say Rs. 700/ Share.

The income tax (I-T) has barred all chartered accountants (CAs) from valuing shares of closely-
held companies.

Earlier, the fair market value of unlisted equity shares was calculated at the option of the
company on either the book value on the valuation date or by the discounted cash flow method.
Calculated by a merchant banker or a CA.

However, the Central Board of Direct Taxes has removed the CAs from the list of authorised
professionals in this regard. From Thursday, only a merchant banker may do this. This change
brings this provision at par with Rule 3 of the I-T Act, which says only a merchant banker may
calculate the value of unlisted shares issued under Employee Stock Ownership schemes.

Interestingly valuation of shares may still be done by CAs under the Companies Act.

So, unlisted shares or unlisted companies may be sold or valued by a CA’s valuation but, for I-T
purposes, it will require a merchant banker’s valuation report.

Sources add that the government is considering a qualifying course for valuation; only those who
clear it may do valuation.

Introduction
The income tax laws of our country have witnessed a lot vicissitudes over the years. Responding
to the changing reforms as well as practices, the law makers have always tried to pace up with
the dynamic economy. Chartered Accountants, in India, are widely accepted as tax professionals
and in that capacity they play a very important role in the comprehending the income tax laws
for the commoners. But a recent change by the IT Department would certainly not please the CA
fraternity in the country.

The change has been brought in Rule 11UA of the Income Tax Rules which deals with the
valuation of various assets for the purpose of sections 56(2)(viib) or 56(2)(x) of the Income Tax
Act. While section 56(2)(x) deals with charging of income tax under the head other sources
where there is a gain due to difference in fair value of an asset and the transaction value of an
asset transferred, section 56(viib) provides for charging of tax under the head other sources,
where any closely held company issues shares at more than fair value of the asset.

Rule 11UA has been divided into two sub rules which provides as follows:

 Sub rule (1) of Rule 11UA determines the fair market value of a property, other than
immovable property
 Sub rule (2) of Rule 11UA determines the fair market value of unquoted shares for the
purpose of section 56 (2)(viib) of the I.T Act, 1961
1. Clause (a) of sub rule (2) of Rule 11UA deals with adjusted net asset value (NAV)
method. Certification of such valuation is silent in the Rules.
2. Clause (b) of sub rule (2) of Rule 11UA deals with the discounted cash flow (DCF)
approach

DCF model indicates the fair market value of a business based on the value of projected cash
flows that the business is expected to generate in future.

Notification issued by CBDT

Central Board of Direct Taxes (CBDT) vide its Notification[1], no
th
-23/2018/F.No.370142/5/2018-TPL dated 24 May, 2018 has made alterations in Rule 11UA(2)
(b), which allowed merchant bankers and chartered accountants for carrying out valuation of the
equity shares using discounted cash flow method. The notification has withdrawn the power
assigned to CAs for determining fair market value of unquoted shares under Discounted cash
flow (DCF) method for the purpose of section 56(2)(viib). The said notification has been made
effective from 24th May, 2018.

The notification has also removed the definition of the term ‘accountant’ as defined under Rule
11U, which defines the meaning of expression used in determination of fair market value for
Rule 11UA.

Therefore, if a closely held company is desirous of issuing further shares and wants to get it
valued under DCF, then it will have to get it done by merchant bankers only.

The table below shows the pre and post scenario of Rule 11UA pursuant to the amendment:
Prior to Amendment Post Amendment

Clause (a) of Rule 11U has been omitted.

Rule 11U defined “accountant“ under clause (a)
“(i) for the purposes of sub-rule (2) of rule 11UA, means a
fellow of the Institute of Chartered Accountants of India
within the meaning of the Chartered Accountants Act, 1949
(38 of 1949) who is not appointed by the company as an
auditor under section 44AB of the Act or under section 224
of the Companies Act, 1956 (1 of 1956); and
(ii)in any other case, shall have the same meaning as
assigned to it in the Explanation below sub-section (2) of
section 288 of the Act;”
(i)for the purposes of sub-rule (2) of rule 11U
fellow of the Institute of Chartered Accounta
within the meaning of the Chartered Accounta
(38 of 1949) who is not appointed by the co
auditor under section 44AB of the Act or unde
of the Companies Act, 1956 (1 of 1956); and
(ii)in any other case, shall have the same
assigned to it in the Explanation below sub-s
section 288 of the Act;”

As per Rule 11UA, sub rule (2), in clause (b), accountants The word “accountant” has been omitted an
and merchant bankers were allowed to value unquoted share merchant bankers are eligible to value unquo
by discounted cash flow approach. discounted cash flow approach.

(b)the fair market value of the unquoted equity shares (b) the fair market value of the unquoted e
determined by a merchant banker or an accountant as per determined by a merchant banker or an acco
the Discounted Free Cash Flow method the Discounted Free Cash Flow method.

Conclusion

The above amendment is only with respect to the fresh issue of shares by the company using the
DCF approach. However, accountants may still continue to value unquoted equity shares by
adjusted NAV approach as per sub rule (1) and sub rule (2) clause (a) of Rule 11UA.

Further, it is to be noted that the word “accountant” is still used in Rule 11UA sub rule (1),
whereas the definition of the term has been omitted from the rules. Therefore, the apparent
question that arises is with respect to the meaning of the term “accountant”. In this regard,
explanation (2) to section 288 of the Income Act can be referred to. Extracts provided below:

Explanation to sub-section (2) of section 288 of the Act;

In this section, “accountant” means a chartered accountant as defined in clause (b) of sub-
section (1) of section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a valid
certificate of practice under sub-section (1) of section 6 of that Act, but does not include [except
for the purposes of representing the assessee under sub-section (1)]

If one was to compare the professional charges and availability of Chartered Accountants and
Merchant Banker, definitely CA’s will hold an upper hand in terms of their availability and
economical charges. Also, the ratio of Merchant Bankers to the companies falling under the
ambit of Rule 11UA is very wide keeping in mind the strength of Merchant Bankers in the
market. This amendment will also increase the cost burden of the company for performing
valuation of their fresh issue.

There is hue and cry in the CA fraternity and the Institute of Chartered Accountants of India
(ICAI) has been taking efforts to subdue the notification and have also made a written
representation to the CBDT[2] for withdrawing the notification.

[1] https://www.incometaxindia.gov.in/communications/notification/notification23_2018.pdf
[2] https://resource.cdn.icai.org/50361dtc300518.pdf

Background
Historically, as an anti-abuse measure, Indian tax laws taxed an individual and a Hindu
Undivided Family (HUF) when specified assets were received for inadequate consideration or
without consideration. These included a sum of money, immovable property, shares and
securities, jewellery, archaeological collections, drawings, painting, sculptures or any work of
art, and bullion.
However, partnership firms - including limited liability partnership firms - and private companies
were taxed only in relation to receipt of shares of closely held companies.

Introduction Of Amendments Via Finance Act, 2017

The Finance Act, 2017 has brought in the following amendments aimed at curbing tax
avoidance:
 Applicability of anti-abuse provisions: A specific amendment was introduced to widen
the ambit of the above anti-abuse provision by covering all taxpayers.

 Taxation for transferor on transfer of unlisted shares at below Fair Market Value
(FMV):Anti-abuse provisions were applicable only to the recipient of specified properties and
there were no provisions (except transfer pricing provisions which apply in case of
international related party transaction) to tax the transferor where unlisted shares were
transferred at less than the FMV. To address this, a new section was introduced to tax the
 transferor on the FMV value of unlisted shares if the actual sale consideration was less than the
FMV even in an unrelated party transaction.

Draft Rules For Determining The FMV Of Unlisted Equity Shares

The provisions introduced via the Finance Act, 2017 delegated the methodology for
determination of the FMV through rules to be issued by the Central Board of Direct Taxes
(CBDT). Subsequently, CBDT published draft rules for public comments which substitute the
existing valuation rules for unlisted equity shares. The rules, once finalised and notified, apply
from April 1, 2017 on both the transferor and transferee to determine the FMV.

Impact Analysis
 The requirement of valuing specified capital assets at FMV: The draft rules provide
for the valuation of specified capital assets (owned by the company whose shares are being
transferred) at FMV as opposed to the extant rules stipulating them to be valued at book value.
This calls for a cumbersome procedure to be followed to determine the FMV of unlisted equity
shares, thereby impacting inter-se restructuring among group entities and giving effect to
genuine commercial arrangements between unrelated parties, such as distress sale. For
example, the rule requires immovable properties to be valued at stamp duty value.
Determination of stamp duty value for factories situated in remote areas could be arduous.
Also, ambiguity exists on whether building and plants and machinery - which is attached to the
surface of the land) are considered as immovable property and the manner in which FMV
should be determined (in absence of stamp duty value).

 Retroactive application with effect from April 1, 2017: The valuation rules are
proposed to be made applicable with retrospective effect from April 1, 2017. This could lead to
the creation of inadvertent implications for various stakeholders (such as parties to the
transaction and/or representative assesses) who may have relied upon the existing valuation
rules based on the book value for consummating the transaction. This would lead to a higher
tax burden and an uncertain tax environment. This would also be in conflict with the avowed
stance of the current government against the introduction of retrospective amendments.
Considering this, various stakeholders need to assess the impact of the new FMV valuation
rules - on transaction already in effect after April 1, 2017, or those that proposed to be
consummated in future - and raise their concerns to CBDT, which can be addressed before
notifying the final rules.

 Valuation approach: The virtual look-through approach (in the form of lifting the
corporate veil to determine FMV for direct and indirect investments in shares and securities)
for determination of the FMV of unlisted equity shares will increase tax complexity involved in
share transfer transactions and the consequential litigation. To illustrate, even for a simple intra-
group transfer of shares of a closely held company, FMV would need to be determined for all
the downstream companies in the chain as on the date of the transaction.
  Minority interest: It would be practically difficult for minority shareholders to
determine the valuation of unlisted equity shares under the new valuation rules, as they may not
have access to all the relevant information. CBDT could prescribe minimum threshold criteria
(in terms of transaction value or percentage holding) in this regard.

 Conflict with existing provisions under Indian tax law: The new valuation rules may
create conflict in respect of transactions which are covered by other provisions of the tax law,
such as transfer pricing, or where the applicable regulatory provisions (such as foreign
exchange regulations) may provide differential FMV determination.

 Ambiguity regarding valuation of preference shares: Although the anti-abusive

provisions cover the transfer of both equity and preference shares at less than FMV, the rules
only provide a mechanism for the calculation of FMV of unlisted equity shares. Accordingly,
CBDT needs to provide guidelines for the valuation of preference shares in the final valuation
rules.
Although rules will need some tweaking, the intention of the CBDT to formulate tax policies
through collective efforts by inviting and incorporating public opinion exhibits international best
practice of consultative approach adopted by the ruling government.