Income tax on transfer of unquoted equity shares at less than Fair Market Value (FMV)

Transfer of shares of listed entities is quite a simple and fair process as the price of shares are available on the stock exchange and shareholders have no option to transfer shares at value other than price available on stock exchange. However, what about the unquoted or unlisted equity shares. Whether shareholders can transfer such shares at any price or is there any mechanism specified for the same?

Transfer of unlisted equity shares is a transaction between two shareholders and the same is carried out at the price agreed upon between shareholders. Now the obvious question arises is whether shareholders can transfer the unlisted equity shares at price less than Fair market value of such shares? So, yes shares can be transferred at value less than FMV of shares. Free and unregulated trade of unquoted shares led to utilization of the provisions to abusive practices where companies were avoiding capital gains tax on transfer of shares, by valuing the shares very low and escaping tax.

To prevent such practices, Finance Act, 2017 introduced anti-abuse Section 50CA. This section shall consider the fair market value of the unquoted shares for computation of capital gain instead of transaction value.

In case of transfer of shares at value less than Fair Market Value, income tax provisions are applicable on both transferor and transferee.

This article discusses income tax implications on transfer of unquoted equity shares at price less than Fair Market Value.

1. Tax Implication in hands of transferor of shares

1.1 Sales consideration for Computation of Capital gains

As per Section 50CA of Income Tax Act, Where the consideration for transfer of share of a company, other than a quoted share, is less than the fair market value of such share then such fair market value shall be considered as consideration for computation of capital gains under Section 48.
Fair market value of the unquoted shares shall be computed as per Rule 11UAA of Income Tax Rules.
“Quoted Shares” means the share quoted on any recognised stock exchange with regularity from time to time, where the quotation of such shares is based on current transactions made in the ordinary course of business.

1.2 Manner of Computation of Fair Market Value of Unquoted Shares

As per Rule 11UAA, for section 50CA, the fair market value of unquoted shares shall be determined as per the formula given under sub-clause (b) or (c) of Rule 11UA(1)(c) of Income Tax Rules.
As per Rule 11UA(1)(c) of Income Tax rules, Fair market value of the unquoted shares can be computed in following manner:
FMV of Unquoted Equity Shares (Sub-clause (b)):

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 unamortised amount of deferred expenditure which does not represent the value of any asset;

B= Fair market value of the jewellery and artistic work as per 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= Value of Immovable Property as opted for the purpose of payment of stamp duty;
L= book value of liabilities shown in the balance sheet. However, it shall not include following amounts:
- 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;
- reserves and surplus (including negative balances), other than those set apart towards depreciation
- Provision of Income Tax reduced by Income tax paid (advance tax, TDS or TCS)
- Provisions for made for meeting liabilities, other than ascertained liabilities;
- Contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PV= Paid up value of equity shares to be transferred
PE= total amount of paid-up equity share capital as shown in the balance sheet

FMV of unquoted shares and securities, other than equity shares
- the FMV of unquoted shares and securities, other than equity shares, shall be estimated sales price on the valuation date and the assessee may obtain a report from a merchant banker or an accountant for such valuation.

1.3 Which date should be considered for computation of Fair Market Value

As per Rule 11UA, fair market value of unquoted equity shares shall be the value determined as on valuation date.
As per Rule 11UAA, for the purpose of Rule 11UA, valuation date shall be the date on which asset is transferred.

2. Tax Implication in hands of transferee of shares

With anti-abusive provision of Section 50CA, corresponding amendment was also made in Section 56(2)(x) of Income Tax Act. Earlier, Section 56(2)(x) provides for taxability of any money or immovable property received without any consideration or for value less than fair market value.

With effect from 01.04.2017, new sub-clause (c) was inserted to section 56(2)(x) which provided for taxability of any property, including shares, received without consideration or for value less than fair market value.

2.1 Computation of Income in hands of transferee of unquoted shared

As per Section 56(2)(x)(c), when any property, other than immovable property is received without consideration or without adequate consideration then following amount shall be considered as “Income under head other sources::
- Fair Market value of property, where property is received without consideration;
- Fair Market value of property reduced by consideration given, where property is received for inadequate consideration

Provisions of Section 56(2)(x)(c) shall not apply where above mentioned income is upto INR 50,000.

2.2 Non applicability of provisions of Section 56(2)(x)

As per Section 56(2)(x), clause (x) shall not apply to any sum of money or any property received:
- from any relative; or
- on the occasion of the marriage of the individual; or
- under a will or by way of inheritance; or
- in contemplation of death of the payer or donor; or
- from any local authority as defined in the Explanation to Section 10(20);
- from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or
- from or by any trust or institution registered under section 12A or section 12AA or section 12AB; or
- by any fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to Section 10;
- by way of transaction not regarded as transfer under section 47; or
- from an individual by a trust created or established solely for the benefit of relative of the individual;
- by an individual, from any person, in respect of any expenditure actually incurred by him on his medical treatment or treatment of any member of his family, for any illness related to COVID-19 subject to such conditions, as the Central Government may, by notification in the Official Gazette, specify in this behalf;
- by a member of the family of a deceased person,—
  - from the employer of the deceased person; or
  - from any other person or persons to the extent that such sum or aggregate of such sums does not exceed INR 10,00,000

where the cause of death of such person is illness related to COVID-19 and the payment is—

received within 12 months from the date of death of such person; and
subject to such other conditions, as the Central Government may, by notification in the Official Gazette, specify in this behalf.

3. Double taxation under Section 50CA and Section 56(2)(x)

In case of transfer of unquoted equity shares for value less than FMV, transferor of shares is liable to pay Income tax under capital gains considering Fair Market Value of the shares as sales consideration. Therefore, the transferor is liable to pay Income tax on the difference between FMV and actual sales consideration.

On the other hand, the transferee is liable to pay Income tax on the difference between FMV and actual sales consideration under head other sources. Hence, there is a double taxation.

Same can be understand with below mentioned example: