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New I-T rules may lead to double taxation, circumstantial valuation difficulties for share transfer

The Act currently provides for income taxable as 'capital gains' to be computed after taking into account the full value of consideration received or accrued on transfer of a capital asset

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"A person doesn't know how much he has to be thankful for until he has to pay taxes on it." -Anonymous

The Finance Act 2017, in an attempt to clarify ambiguities in the extant income-tax law, revamped the mode of taxing the receipt of a sum of money, property or shares for no or inadequate consideration with the introduction of Sections 50CA and 56(2)(x) in the Income-Tax Act, 1961. In prior years, Sections 56(2)(vii) and (viia), respectively dealt with the taxation of money and property received by individuals and Hindu Undivided Families (HUFs) and the taxation of shares of companies (other than public companies) received by firms and companies for no or inadequate consideration. The disconnect between these two sections despite similar objectives (preventing the transfer of assets for inadequate consideration) seems to have prompted their replacement by Section 56(2)(x).

Interestingly, 56(2)(x) brings all the assessees under its ambit – individuals, partnerships and companies, closing the gap for misuse of the provisions that may arise from varied interpretations. There are some exceptions, such as the receipt of money or property on marriage or inheritance, or receipts by charitable trusts or institutions. Additionally, contributions to a trust established for the benefit of relatives of an individual are not covered. There may be further scope for carving out of genuine transfers between group companies. For instance, the transfer of assets by a holding company to its wholly owned subsidiary is ordinarily exempt from capital gains tax under Section 47(iv) but prima facie, 56(2)(x) seems to tax this transaction.

The Act currently provides for income taxable as 'capital gains' to be computed after taking into account the full value of consideration received or accrued on transfer of a capital asset. Section 50CA prescribes that in the case of unquoted equity shares, if the value of such a share is less than the fair market value (FMV) determined in the prescribed manner, then capital gains in the hands of the transferor would need to be determined utilising this computed value as the full value of consideration. Further, Section 56(2)(x) provides for tax on the same unquoted equity shares received for inadequate consideration, but in the hands of the recipient. These new provisions were hailed as anti-abuse provisions, remedying the opportunity for undervaluing consideration, resulting in lower taxes but at the same time, seem to double tax the same transaction of transferring unquoted equity shares for inadequate consideration.

For determining the FMV of unquoted shares, the Central Board of Direct Taxes (CBDT) notified the relevant rules on 12th July, 2017, in which fair value or open market value, of jewelry, art, immovable property, shares and securities and the book value of other relevant assets and liabilities are to be considered. These rules are to be effective from 1st April, 2018, i.e., the assessment year 2018-19 and do not seem to digress substantially from the draft rules circulated in May 2017.

Under the erstwhile provisions, when unquoted equity shares were transferred, their FMV was determined in accordance with the book value of assets and liabilities as per the balance-sheet and not FMV/stamp duty value. However, these new rules may give rise to circumstantial valuation difficulties such as valuation of securities in case of cross-holdings among group companies, valuation of companies in a multi-layered structure or valuation of immovable properties, which require a value as adopted by a government authority to be used.

Despite these concerns, these revised valuation rules are not only commensurate with the character of the transaction on hand but also usher in greater transparency and simplicity in the valuation of unquoted securities. Further clarity is awaited from the revenue department on the issue of potential double taxation and the impact on genuine restructuring endeavours remains to be seen.

The writer is partner - tax, KPMG India.
(Shradha Mani of KPMG India contributed to the article)
The views and opinions expressed herein are those of the authors and do not reflect the views and opinions of KPMG in India.

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