Amendment to Section 56(2)(x) & Section 50CA of the Income Tax Act

Author: Aeshita Marwah, University of Petroleum & Energy Sciences.

According to Article 56(2)(x) of the Income Tax Act¹, a person shall be liable in the hands of the recipient for any property including the shares in a corporation for consideration below fair market value. In Sec 56(2)(x) of the Income Tax Rules, Article 11 of the proviso says some kinds of taxes not included under the Income Tax Act following Article 56(2)(x).

The notice no. 40/2020 of the Central Board of Direct Taxes (CBDT) video dated 29 June 2020 changed the aforementioned rule 11UAC by the above-mentioned IT rules. As provided in the amended regulation, the provisions of Sec 56(2)(x) of the Income Tax Act do not apply to the assessment year 2020-20020 or the following evaluation years, but are applicable on the first day of April 2020:

1. Any real property, land, or building that the Central Government acquires from an unauthorized colony residence in the Delhi Territory of Capital when its transactions in this immobility are regulated by a central government based on documents provided for the benefit of the person concerned;
2. Any moving property of the undertaking and its subsidiary received as unquoted shares by the shareholder and by that subsidiary where: 

• The National Company Law Tribunal (‘NCLT’)² suspended the board of directors and appointed new directors chosen by the Central Government on application by the Central Governments according to Section 2412 of the Companies Act in 2013;

• Following a resolution plan agreed under Section 242 of the Companies Act, 2013 NCLT, the share of the firm and its subsidiary and the subsidiary of that subsidiary has been received

3. Any moveable property, being the share of the rebuilt bank, that has been obtained following the yes bank reconstruction scheme by the investors or the investor bank (at a price stipulated in this scheme)

Furthermore, the fair value of such consideration shall be considered to be the full value of the consideration received for purposes of calculating the capital gains as set out in Article 50CA of the IT Act when the consideration received for the transfer of an unquoted share is less than the fair market value (in conformity with the procedure specified); The CBDT video – Notification3 of 30 June 2020 included Rule 11UAD in the IT Rules, which would not apply to unquoted shares transfer of a firm, it is subsidiary or a subsidiary of the subsidiary specified in paragraph 2 above, under Article 50CA of the IT Law. 

Cases that might have led to the amendment 

Bhoruka Engineering Inds. Ltd. v. DCIT 

In this instance, Revenue argued that the stock sales transaction is a colorful mechanism and that essentially real estate is transferred. Although the Supreme Court rejected that claim, it noted that “the evaluation by recourse to such tax planning took advantage of the advantage that the legislation has brought or the loopholes it has secured for it. Seeing that the lapse was exploited within four corners of the legislation, Parliament is ready to amend the statute that plugs the lapse.”

DCIT v. Maya Appliances (P.) Ltd

In this situation, the assessments sold the real property and the building for the sale of shares are according to Revenue, and thus the rules under Section 50C apply. However, given there were no direct transfers of the land or the buildings or both, the Tribunal refused to take that argument and concluded that it had no issue invoking section 50C of the Act.

Med plus Health Services P. Ltd vs. ITO 

In this situation, the revenues have accepted the market value of unquoted shares that ignores the technique of valuation laid out in Rule 11 UA, since this was based on the asset book value. “A.O. shall, following the manner provided but not as fair market value under section 56(2), (vii(a)) of the law, determine the fair market value. The Tribunal concluded that. In its wisdom, the legislature has also established a fair market value calculation methodology that the authorities below cannot disregard.”

Value of the non-quoted shares 

Clause (x) of Article 56(2) was retained, even after insertion, as applicable to clauses (vii) and (vii (a)) of Article 56(2) of the Act to evaluate the unquoted shares. Clause (x) has been allocated in this respect. The new Rule 11UA, however, was developed by the CBDT and incoherent with the previous Rule 11UA.

Recently, the CBDT issued amended Regulation 11UA to allow the evaluation of unquoted inventory values. Final assessment rules. Substitution under final rule 11UA(1)(c)(b) of the preceding regulations states that uncoated stock calculations of FMV shall be computed as follows: Rules of the final assessment

FMV of unquoted shares = (A+B+C+D-L) x PV/PE, where

• A – All properties book value (except for those indicated in B, C, and D) reduced by income tax payable (net of return) B – Fair market value of gemstones and creative works based on a registered value assessment report C – Fair stock or securities value as defined by this regulation.
• D – Stamp duty assessment for any real estate
• L – Book value of debts, excluding paid share capital, unregistered dividend amount, reserves and surpluses, tax provision, uncertain provisions
• Contingent liabilities and liabilities PV – Equity paid-up value PE – Total capital paid up as stated in the balance statement.

Justification/Explanation 

• B = the amount the jewelry and creative work would be charged if sold on the grounds of the assessment report from the registered value owner in the open market;
• C = the value, as established under this regulation for shares and securities, taken or validated by any government authorities for payment of stamp duties on the immovable property; D = the value, or value, for all governmental authorities.
• L = liabilities book value indicated on the balance sheet, but
• not to include the following amounts, specifically:

• Capital paid up for shareholdings;
• The amount set up for dividend payments to the preferential shares and share of the equity if such dividends were not declared at a general meeting of the company before the date of transfer;
• Reserves and surpluses with any name other than those set apart by depreciation, even if the outcome is negative;
• Any sum, save for income tax paid if any, less the amount of income tax claimed as refund, if any, above tax payable about book profit in conformity with the relevant legislation; any amount indicating a provision for taxation, other than income tax paid;
• Any sums, other than asserted obligations, reflecting reserves for fulfilling liabilities;
• Any other than arrears of dividends due in respect of cumulative preference shares, representing the outstanding obligations;
• PE = total capital equity paid-up as indicated in the balance sheet;
• PV= the amount paid-up of such shareholdings;

The new rule of 11UAA requires the FMV of equity in a society other than a quoted share for section 50CA to be calculated in the form referred to in Rule 11UA(1)(c)(b)(c) and the date of the transfer of such shares to be the date referred to in Rule 11U and Rule 11UA.

The Finance Act 2017 introduced the new section 50CA to provide that the fair market value of such shares as prescribed is considered to be the full value of the consideration, if shares of a company other than quoted shares are transferred for computing income taxable as capital gains, of such shares.

In addition, the explanation in this section specifies that a “quoted share” is the share quoted from time to time on any recognized stock exchange if the quotation for the share is based on actual business transactions.

To provide for the taxation of immovable property in instances where an individual acquires unresolved property and their stamp duty exceeds R.50,000 following the Finance Act 2017, a new paragraph (x) of subparagraph (2) of section 56 was introduced.

Such taxation would apply to the recipient under the title ‘Resources from other sources.’ Similarly, if any individual receives property under insufficient consideration and the gap between the value of the stamp duty to actual consideration exceeds Rs.50.000. Clause (x)(c) provides for any property obtained by any person other than real property –

1. Without accounting for the overall fair market worth of more than fifty thousand rupees, the total fair market value of such property shall be taxed as “income from other sources.”
2. For considerations that surpass the aggregate fair market value of the property, which exceeds that consideration, the ‘profit from other sources’ tax shall be subject to an amount exceeding fifty thousand rupees.
3. Following the aforementioned regulation, double taxation is based on the following example for the identical income

Example 

In this respect, Rs. 1 crore, for example, shall be the fair market value of the shares, as necessary. X transfers its unpaid portion to Rs. 10 lakhs to ‘Y,’ which is purchased for Rs.8 lakhs. In that situation, the provisions of Section 50CA would be placed in the hands of a salesperson whose whole value for the computation of capital gains would be Rs.1 crore. In other words, in line with Article 56(2)(x)(c), the buyer of ‘ Y’ shall be subject to tax on the income from other sources for Rs. 90 lakhs (i.e. Rs. 1 crore fewer Rs. 10 lakhs). 

The difference between fair market value and actual consideration of ₹ 90 lakhs are thus taxable:

1. In the hands of the seller under section 50CA;
2. In the hands of the receiver, under clause 56(2)(x).

Moreover, even if the receiver would regard the FMV as the cost of procurement at the time of sale of such shares, the tax was collected at an initial stage and it could occur that the person cannot sell the shares later.

Valid suggestions 

1. Concerning both sellers and recipients, suitable adjustments may be made to avoid unjustified income increases as a result of the following double taxes resulting from the same income.
2. This is a highly subjective and complex concept of listed equities. Indeed, there may be problems of interpretation and interminable processes may emerge. This rule thus should apply to the share of a company that does not concern the public. This is why it is suggested.

The provisions of Section 50CA: an analysis

1. No mechanism was available under the Act to substitute for the full value of consideration as revealed by the assessee for the calculation of capital gain before the introduction of the provisions of section 50CA, for consideration which was not in conformity with the fair-market value of the shares, as disclosed by the assessee for consideration. The transfer of capital assets, which include islands or constructions, or both, is covered by Section 50C which is not applicable in the case of shares. The 50CA clause has been created to fix this gap.
2. Applicable to all the shareholders (resident, non-resident, related entity, and non-related entity.
3. A capital asset should be unquoted shares
4. Not applicable for profit from the transfer of shareholder interest, trust where the properties have been transferred
5. These entities consist of immovable property, either directly or indirectly
6. May even encompass certain quoted shares based on a “quoted share” definition
7. No supplied band tolerance. Therefore, FMV is regarded as the complete value of consideration according to the new formulation technique, albeit the difference in FMV and the selling consideration is minor.
8. The seller shall be charged following section 50 CA, if the consideration for sales is less than FMV, for the reason that it has not disclosed genuine consideration. On the other hand, the buyer shall be imposed on it based on the purchase consideration under paragraph 56(2)(x).

Conclusion 

The revised FMV calculation method is based on the amended Net Asset Value Method with certain FMV assets and residual book value. Thus, while dealing with immovable property, it is necessary to take into account the FMV of jewelry, crafts, shares and stocks, and stamp value.

1. Where unquoted equity values are generated primarily from immaterial assets like goodwill, marks, or other immaterial property, such a valuation approach must not be based on the real worth of the company’s shares.
2. The authorized valuation technique does not evaluate whether or not shares subject to transfer have minority or majority interests. Asset valuations are normally beyond the minority shareholder’s reach.
3. The required valuation technique is particular to paragraphs 50 CA and 56(2)(x) and does not apply to any other paragraph, even though the word FMV is a phrase used by several locations within the law.
4. Three chances of contradiction may arise in the case of the non-resident between the regular rules, i.e. Section 50CA and Section 56(2)(x) and the transfer pricing requirements.
5. There may be issues with withholding tax. Suppose a non-resident seller transfers certain non-resident shareholdings per share to a total of Rs. 100 residents, however in line with the current assessment approach the GTF will be Rs. 500 per share. The capital gain is Rs. 50/share or Rs. 450/share, to cover the cost of shares purchased by a non-resident (if FMV of share is considered). It remains unclear in this regard whether a resident payor retains the tax according to section 195 for Rs. 50 or Rs. 450.
6. The issuer is empowered to assess the market value of the underlying assets, including intangible assets if the conditions of section 56(2) (vii(b)) are relevant.

[1] Income Tax Act, 1961,Cost of aquisition

[2] Quasi-Judicial Body under Government of India.