Under valued consideration on sale of shares is taxable

Under valued consideration on sale of shares are taxable in the hands Firm and Company  

Introduction

After  various gifts received by Individual and HUFs  brought under the provisions of Income Tax act, the amount received by the firm and company are also brought under the ambit of income tax provisions w.e.f.01.06.2010 to carve out the tax evasions carried out through purchase of shares without consideration or under consideration than the fair value of the share. This can in other terms be treated as gifts and the taxability of such Gifts received by firm or Closely Held Company (not being a company in which public is substantially interested) is governed by the section 56(2)(viia) of the income Tax Act. However gifts received by AOP, BOI and Trusts are still not covered under the Provisions of Income Tax Act   

Provisions as applicable to taxability of value of shares (Gifts) as per income tax Act from 01.06.2010 onwards

Tax is leviable on such gift under the head of Income from other sources’ under section 56(2) (viia), if it satisfies the following conditions:

A)  It is received by Firm or Closely Held Company includes LLP

B)  It is received on or after 01.06.2010

C)  It is received from any person or persons whether resident or Non-Resident

D)  It is transfer of Shares whether Equity or Preference

E)  It belongs to any of the following category:-

i)  Without consideration, the aggregate Fair Market Value of which exceeds Rs.50,000, the whole of the Fair Market Value of such shares.

ii) For a consideration which is less than Fair Market Value of shares by an amount exceeding Rs.50000, the aggregate Fair Market Value of such shares exceeds such consideration.

We will try to understand the above noted provisions of Section 56(2) (viia),  as applicable with the help of certain instances  given here under. For Example, Y ltd is a partnership firm/ closely held company, receives the following assets:

Tr.No.	Particulars of Transfers	Consideration Amount	FMV	Remarks
1	FDR on 01-07-2010	Nil	1500000	Not covered u/s 56(2) (viia) as it is transfer of FDR
2	Shares in X ltd (Listed Public Company) on 01-04-2011	Nil	1000000	Not covered u/s 56(2) (viia) as shares transferred are not of a closely held company
3	Shares in Z ltd(Listed Public Company) on 10-08-2011	50000	500000	Not covered u/s 56(2) (viia) as shares transferred are not of a closely held company
4	Shares in A ltd(closely held company) on 01-04-2010	Nil	1000000	Not covered u/s 56(2) (viia) as shares are transferred before 01-06-2010
5	Ø      Shares in B ltd(closely held company) on 01-08-2010 Ø      Shares in C ltd(closely held company) on 01-10-2010	Nil Nil	10000 40000	Not covered u/s 56(2) (viia) as aggregate FMV of both transfers of shares does not exceeds Rs.50000/-
6	Ø      Shares in D ltd(closely held company) on 01-06-2011 Ø      Shares in E ltd(closely held company) on 01-09-2011	40000 20000	70000 40000	Not covered u/s 56(2) (viia) as aggregate difference between FMV and cost of acquisitions of shares does not exceeds Rs.50000/-
7	Ø      Shares in F ltd(closely held company) on 01-09-2011 Ø      Shares in G ltd(closely held company) on 01-11-2011	Nil Nil	30000 40000	Covered u/s 56(2) (viia) as aggregate FMV of both transfers of shares exceeds Rs.50000/-
8	Ø      Shares in H ltd(closely held company) on 01-08-2011 Ø      Shares in K ltd(closely held company) on 30-09-2011	30000 50000	70000 70000	Covered u/s 56(2) (viia) as aggregate difference between FMV and cost of acquisitions of shares  exceeds Rs.50000/-

Calculation of Fair Market Value of Shares for the purpose of Section 56(2)viia

As per Rule 11UA(c) the valuation of shares and securities shall be done as under –

(a) Fair market value of unquoted equity shares: 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

= (PV)*(A-L) / (PE)

Where, A= Book value of the assets in Balance Sheet as reduced by any amount paid as advance tax under the Income-tax Act and any amount shown in the balance sheet including the debit balance of the profit and loss account or the profit and loss appropriation account 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:-

(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, by whatever name called, other than those set apart towards depreciation;

(iv) credit balance of the profit and loss account;

(v) any amount representing provision for taxation, other than amount paid as advance tax 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;

(vi) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vii) 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 Balance Sheet.

PV = the paid-up value of such equity shares.

(b) Fair market value of other unquoted shares and securities: 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 assessee may obtain a report from a merchant banker or an accountant in respect of such valuation.

Some important meanings and points are as under:

1.Closely Held Company: A company whose shares of common stock is owned by relatively few individuals and is generally unavailable to outsiders. Such companies do not have their shares of ownership offered on stock exchanges

2. Person (Sec.2(31)): The Term includes

Ø      an individual

Ø      a Hindu undivided family

Ø      a company

Ø      a firm

Ø      an association of persons or a body of individuals, whether incorporated or not

Ø      a local authority

Ø      every artificial juridical person, not falling within any of the preceding categories

3. Section 56(2)(viia) does not apply to the following

i)    Transfer of shares in closely held Indian company in scheme of amalgamation between two foreign companies (Section 47(via))

ii)   Transfer of shares in closely held Indian company by demerged foreign company to resulting foreign company (Section 47(vic))

iii)  Transfer on reorganization of two co-operative banks (Section 47(vicb))

iv)  Transfer or issue of shares by resulting company in scheme of demerger to shareholders of demerged company (Section 47(vid))

v)   Transfer by shareholder in scheme of amalgamation of shares held in amalgamating     company (Section 47(vii))

Contributed By :

Ms. Lipsy Garg(Pursuing CA Final)
Article With Shiv Jindal & Co.
Under the Guidance of CA. Vikram Jindal, Ludhiana