Tax Insights
from India Tax & Regulatory Services
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Tribunal holds that valuation of shares under section 56(2)(viib) of the Act, based on the fair value of assets, cannot be rejected
November 6, 2019
In brief
The Delhi bench of the Income-tax Appellate Tribunal (Tribunal) held that where the taxpayer has demonstrated with evidence that the fair market value (FMV) of an asset is much more than the book value, the tax officer (TO) cannot use the book value of the asset, ignoring its FMV, for valuation of shares under clause (ii) of Explanation (a) to section 56(2)(vii)(b) of the Income-tax Act, 1961 (Act).
The Tribunal further ruled that shares should be valued based on various relevant factors and not merely based on financials.
In detail
Facts
• The taxpayer company1 filed its tax return for a financial year declaring a loss.
• During the same year, the taxpayer had issued shares at a premium.
• The taxpayer owned agricultural land. On 14 June 2012, the competent authority allowed the land to be used for setting up a convention centre. This resulted in a change in the fair value of the land.
• The TO determined the FMV of shares under Rule 11UA of the Income-tax Rules, 1962 (Rules) and added the entire premium
1 ITA No. 7262/ Del/ 2017
to the total income of the taxpayer.
• The Commissioner of Income-Tax (Appeals) [CIT(A)], considering the share application money as a liability and correcting certain other error in the valuation of the TO, revalued the shares. Thus, a partial relief was given to the taxpayer as against the original relief claim.
Issue before the Tribunal Whether the CIT(A) had erred in not considering the FMV of land owned by the taxpayer for calculating the value of shares?
Taxpayer’s contention
• The competent authority allowed the land to be used for setting up a convention centre. This resulted in a
change in the fair value of the land.
• As per Explanation (a) to section 56(2)(viib) of the Act, FMV of shares shall be the higher of the value determined under Rule 11UA of the Rules or the value of taxpayer’s assets as substantiated by the taxpayer to the satisfaction of TO.
• TO cannot insist on following one particular method.
• Valuation of shares has to take into consideration various factors and should not be simply based on book value.
• The circle rate of land was substantially higher than
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its book value, and the same should be adopted as the FMV of the land instead of the book value.
• On considering the circle rate of land as its FMV, the value of shares under section 56(2)(viib) of the Act is determined at a much higher rate than the premium rate at which the shares were issued by the taxpayer. Therefore, no addition is called for under section 56(2)(viib) of the Act.
Revenue’s contention
• The taxpayer had failed to explain how the change in land use for institutional purpose would increase the fair value of shares.
• In the absence of cogent reasons substantiating the increase in FMV of land, the book value of the land should be considered as a metric for valuing the shares of the taxpayer.
• The conversion charges paid by the taxpayer to local authorities for obtaining change in land use
permission would have been added to the book value of land, thereby increasing its value to that extent.
Tribunal’s ruling
• Valuation of shares has to be made on the basis of various factors and not merely on the basis of financials.
• Explanation (a) to section 56(2)(viib) of the Act prescribes that the FMV of shares shall be the higher of the value determined under Rule 11UA of the Rules or the value of taxpayer’s assets as substantiated by the taxpayer to the satisfaction of TO.
• The taxpayer had obtained the permission of the competent authority for change of land use from agricultural to institutional, resulting in higher circle rate of land.
• Valuation adopted by the taxpayer cannot be rejected where the taxpayer has demonstrated with evidence that the FMV of the asset is much more than book value.
• Hence, the FMV of shares as substantiated by the taxpayer should be accepted and addition of share premium made by the TO and confirmed by the CIT(A) is deleted.
The takeaways
• The judgement dispels the cloud of uncertainty
surrounding the valuation of assets for computing FMV of the shares of a company under Explanation (a)(ii) to section 56(2)(viib) of the Act.
• It comes as a relief to taxpayers by principally upholding that the issue of shares at a price based on fair value, of underlying assets, demonstrated with evidence by the taxpayer should not face the wrath of section 56(2)(viib) of the Act.
Let’s talk
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