Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Tribunal holds that preference
share capital should be included in total liabilities for valuing
unquoted equity shares under Rule 11UA
January 9, 2020
In brief
Recently, the Delhi bench of the Income-tax Appellate Tribunal (Tribunal)1 held that while arriving at the fair market value (FMV) of unquoted equity shares under Rule 11UA of the Income-tax Rules, 1962 (Rules) preference share capital should be included in the total liability of the company. The Tribunal clarified that preference shares were non-convertible, non-cumulative and redeemable; thus, the company was liable to pay this amount to its preference shareholders.
In detail
Facts
• During the financial year (FY ) 2013-2014, the taxpayer sold shares in A Co. The taxpayer offered gains on sale of such shares as long-term capital gains.
• The Delhi co-ordinate bench of the Tribunal in case of the husband of the taxpayer, on identical facts of the case, upheld that the consideration needs to be determined considering FMV of underlying shares and by applying the computation formula provided under Rule 11UA of the Rules.
• The Tax Officer (TO) computed the consideration on the basis of underlying
1 ITA No. 2172/Del/2018
shares and arrived at a v aluation of each share of A Co.
• On appeal, the
Commissioner of Income- tax (Appeals) directed the TO to re-compute the capital gain at a v alue per share that was accepted by the co-ordinate bench in case of the husband of the taxpayer with similar facts.
Issues before the Tribunal Whether redeemable
preference shares have to be deducted as liability under the provisions of Rule 11UA of the Rules?
Taxpayer’s contentions
• The Revenue’s workings of the share valuation of A Co.
under Rule 11UA of the
Rules had many inaccuracies/ errors.
• The computation submitted by the TO contained several errors, as he did not take the correct v alue of the assets, nor did it properly record the liability of intermediary companies, and neither did it consider preference share capital as a liability. This resulted in the adoption of an incorrect v aluation per share without any further verification.
Further, the Delhi coordinate bench of the Tribunal did not examine whether the computation met the norms specified by the said Rule.
Revenue’s contention Once the taxpayer has
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accepted the FMV per share as in the case of the taxpayer’s husband, the same cannot be now challenged on an identical issue.
Tribunal’s ruling The v alue per share
determined by the learned TO, by adopting Rule 11 UA of the Rules, suffers from at least one basic fallacy.
• As per Rule 11UA of the Rules, only the sum of paid-up equity share capital and reserves are not required to be included in the book value of liabilities shown in the balance sheet.
Therefore, its natural corollary is that paid-up capital for preference shares issued by the company is required to be included in the total liability of the company.
• The preference shares are non- convertible, non-cumulative
preference shares, which are redeemable. Thus, the company has a liability to pay the preference share capital to the preference shareholders before anything is paid to the equity shareholders.
• This is the mandate of Rule 11 UA of the Rules, to consider while valuing equity shares of an unlisted entity, to include preference share capital in total liability of the company and to exclude only paid up v alue of equity share capital issued and free reserve. This sum of liability is required to be reduced from the total assets of the company, then only the net book v alue assets representing book value of equity shares of that company can be derived.
• Moreover, in the balance sheet of the company, the equity share capital can be valued
only by excluding the paid-up equity share capital and free reserves, which can be distributed to the equity shareholders.
• The TO is directed to correct the v aluation by including the v alue of preference share capital in the total liabilities.
Such total liability is to be reduced from the total assets to derive the value of equity shares.
The takeaways
This case confirms that preference shares are to be deducted as part of liabilities while calculating the v alue of equity shares as per Rule 11UA of the Rules.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
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