DETERMINATION OF FAIR VALUE OF UNQUOTED SHARES

[Mr. M. GOVINDARAJAN]

Fair value

Section 56 of the Income Tax Act, 1961 (‘Act’ for short) provides for the computation of income from other sources.  Section 56(2)(viia) provides that where a firm or a company not being a company in which the public are substantially 01.06.2010 any property, being shares of a company not being a company in which the public are substantially interested,-

• without consideration, the aggregate fair market value of which exceeds
  Rs.50,000-, the whole of the aggregate fair market value of such property;
• for a consideration which is less than the aggregate fair market value of the property by an amount exceeding Rs.50,000/-, the aggregate fair market value of such property as exceeds such consideration.

Section 56(2)(viib) provides that 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 that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares

The expression ‘fair market value’ of a property is defined as other than an immovable property, means the value determined in accordance with the method as may be prescribed.

Determination of fair market value

Rule 11UA gives the procedure of the determination of fair market value other than immovable property.  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, namely:-

The fair value of unquoted equity shares = (A - L) x PV/PE’’

• Where A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortized amount of deferred expenditure which does not represent the value of any asset;

• L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:-

• the paid-up capital in respect of equity shares;
•  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;
• reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
•  any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
• any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
• any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

• PE = total amount of paid up equity share capital as shown in the balance-sheet;
• PV = the paid up value of such equity shares.

The above said provision was applicable to the assessment years previous to the assessment year 2018 - 19. 

The said rule was substituted vide Notification No. 61/2017, dated 12.07.2017, which came into effect from 01.04.2018.  The newly substituted rule provides that 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, namely:-

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,-

• any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and
•  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:-

• the paid-up capital in respect of equity shares;
• 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;
• reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
• 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;
• any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
•  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.

This substituted amendment would be applicable from the Assessment Year - 2018 - 2019.

In THE PR. COMMISSIONER OF INCOME TAX -6 VERSUS MINDA SM TECHNOCAST PVT. LTD. - 2023 (8) TMI 1116 - DELHI HIGH COURT, the assessee had purchased 48 % of the equity shares of Tuff Engineering Private Limited from three entities the details of which are furnished as below-

• Dhansafal Vypar Limited - 8076650 shares;
• Saket International Private Limited - 800000 shares;
• Minda Capital Limited - 1301150.

The assessee purchased the above shares @ Rs.5/-.  The assessee also produced the certificate issued by the Chartered Accountant who valued the share @ Rs.4.96 under Rule 11UA as applicable for the assessment year 2014 - 15.  However the Assessing Officer valued the shares @ Rs.40.72 (Rs.45.72 - Rs.5.00) taking into consideration the provisions of Rule 11UA at the time of passing order.

The Assessing Officer, therefore, add the addition of income as per his valuation to the tune of Rs.11,84,46,336/-.   Being aggrieved against this order the assessee filed an appeal before the Commissioner of Income Tax (Appeals) upheld the assessment order passed by the Assessing Officer, vide its order dated 16.10.2017.  The assessee again filed appeal before the Income Tax Appellate Tribunal (‘ITAT’ for short) against the order of Commissioner of Income Tax (Appeals).  The ITAT allowed the appeal and set aside the order of Assessing Officer and confirmed by the Commission of Income Tax (Appeals).  Against this order the Revenue filed appeal before the Delhi High Court.

The High Court considered the submissions of the Revenue and the assessee.  The High Court observed that it is not in dispute that the formula prescribed in Rule 11UA of the 1962 Rules underwent a change, which resulted in the fair market value of unquoted shares being calculated by, inter alia, taking into account, inter alia, the value of assets such as immovable property, which was adopted by “any authority of the government” for the purposes of payment of stamp duty.  In other words, if immovable property, such as land, had to be taken into account in arriving at the Fair Market Value of unquoted shares by adopting the formula prescribed in Rule 11UA of 1962 Rules with effect from 01.04.2018, i.e., AY 2018-19, the Assessing Officer would have to factor in the value of such land, by taking into account the circle rate prevailing in the area.  The Assessing Officer committed in error in computing the fair market value which was not applicable to the assessment year 2014 - 2015 for the present case.  This error was also committed by Commissioner of Income Tax (Appeals).  The ITAT corrected the impugned order passed by the Assessing Officer.  The High Court found no error on the order of ITAT.