Introduction
Section 50CA of the Income Tax Act, 1961 is a provision introduced in the Finance Act, 2017. The main aim: to curb the practice of undervaluing shares in certain transactions. This section provides for the determination of the fair market value for the transfer of shares. The aim of this provision is to ensure that the transfer of shares is done at an arm’s length price. It also aims to prevent the erosion of the tax base due to undervaluation.
In this article, we will discuss the implications of Section 50CA and the determination of fair market value. We will also look at the issues of double taxation that arise due to this provision.
Relevant Text of the Section 50CA: –
Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being a share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of the consideration received or accruing as a result of such transfer:
Provided that the provisions of this section shall not apply to any consideration received or accruing as a result of a transfer by such class of persons and subject to such conditions as may be prescribed.
Explanation.—For the purposes of this section, “quoted share” means the share quoted on any recognized stock exchange with regularity from time to time, where the quotation of such share is based on current transactions made in the ordinary course of business.
Key features of Section 50CA of the Income Tax Act are as under: –
- Section 50CA of the Income Tax Act is applicable to both residents and non-residents. If you are a non-resident who wants to evaluate how this may impact your capital gains tax, you can contact us for evaluating this in detail HERE.
- There is a transfer of shares of a company, other than a quoted share. “Quoted share” means the share quoted on any recognized stock exchange with regularity from time to time. Such shares can be equity shares or preference shares or compulsorily convertible preference shares ;
- The consideration for the transfer of such shares is less than the prescribed fair market value of such shares. The fair value has to be computed in a prescribed manner as per Rule 11UA. If you need assistance with the review of methodology for your computation of Rule 11UA, you can contact us for evaluating this in detail HERE.
What will be the Value of Consideration under Section 50CA?
Section 50CA has significant implications for both the buyer and seller of shares. Under this section, if the consideration received or accruing as a result of the transfer of shares is less than the fair market value of such shares (not being quoted share), then the fair market value will be deemed to be the full value of consideration for the purpose of computing capital gains tax. This means that if the actual consideration received for the transfer of shares is lower than the fair market value, then the capital gains tax will be calculated based on the fair market value, resulting in a higher tax liability for the seller.
Certain classes of persons are exempt from the applicability of these provisions, subject to prescribed conditions.
What are quoted shares?
Shares quoted in any recognized stock exchange. The quotation of shares is on the basis of current transactions in the ordinary course of business.
Example on 50CA of Income Tax Act
ABC International (USA), earns long-term capital gains on the sale of 10,000 shares of Rahul Vaid Pvt Limited, at a price of Rs. 100 . The fair value computed as per Rule 11UA is Rs. 120. If the Cost of acquisition of such shares is Rs. 10 (assume no forex benefit applicable) and no indexation is required, total deemed consideration for the purpose of Section 50CA shall be?
Answer: 1,200,000
Example to understand Section 50CA
Suppose Mr. X owns 1,000 shares in a company, and he wants to sell them to Mr. Y. The actual consideration agreed upon between Mr. X and Mr. Y is Rs. 10,00,000. However, the fair market value of these shares is determined to be Rs. 15,00,000. In this scenario, Section 50CA will come into effect, and the fair market value of Rs. 15,00,000 will be deemed to be the full value of consideration for the purpose of computing capital gains tax.
Resultantly, Mr. X will have to pay capital gains tax on the difference between the fair market value of Rs. 15,00,000 and the cost of acquisition of these shares. This amount could be significantly higher than if the actual consideration of Rs. 10,00,000 was taken into account. Additionally, if stamp duty is applicable on this transfer of shares, Mr. Y will have to pay the stamp duty on the fair market value of Rs. 15,00,000, even though he paid only Rs. 10,00,000 for these shares.
Determination of Fair Market Share under Rule 11UA
The determination of the fair market value (FMV) of a share of a company (other than a quoted share) is critical in the application of Section 50CA. Rule 11UAA provides the method for determining the FMV of such shares. The rule states that the FMV of such shares shall be determined in the manner provided in Rule 11UA.
- Discounted Free Cash Flow Method: Rule 11UA provides that the FMV of a share shall be the value calculated using the discounted free cash flow method. The discounted free cash flow method involves estimating the future cash flows that the share is expected to generate and then discounting those cash flows to their present value using an appropriate discount rate. The present value of the estimated cash flows is then considered the FMV of the share.
- Net Asset Value Method: Rule 11UA provides that the FMV of a share shall be the value calculated using the net asset value method. The net asset value method involves subtracting the liabilities of the company from its assets and dividing the resulting amount by the total number of shares outstanding. Thus the resulting value is considered the FMV of the share.
The valuation date, as referred to in Rules 11U and 11UA, for the purpose of determining the FMV of shares under Rule 11UAA, shall be the date on which the transfer of the capital asset, being a share of a company other than a quoted share, referred to in Section 50CA, takes place.
Note: It is significant to note that any consideration received or accruing as a result of a transfer by such a class of people and subject to such conditions as may be prescribed is exempt from the provisions of Section 50CA.
Implications of Section 50CA
A buyer may end up paying a higher stamp duty on the transfer of shares. This case may arise if the FMV is higher than the actual consideration paid. This is because stamp duty is typically calculated based on the higher of the consideration paid or FMV of the shares.
The determination of fair market value is therefore a critical aspect of the transfer of shares, as it has significant tax implications for both parties.
The problem of double taxation arises when the sale consideration of unquoted shares is less than the FMV. Section 50CA provides for the adoption of the FMV as the consideration for the transfer of unquoted shares.
Conclusion
In conclusion, Section 50CA of the Income Tax Act, 1961, is an important provision. It is aimed at curbing the practice of undervaluing shares in certain transactions. The determination of fair market value is critical to the application of this provision, as it has significant implications for both the buyer and seller of shares.
Do you need help with the calculation of FMV under Section 50CA of the Income Tax Act, 1961? Contact us today.
Frequently Asked Questions (FAQ)
1. Are provisions of Section 50CA of the Income Tax Act applicable to non-residents?
Yes, Section 50CA of the Income Tax Act is applicable to both resident and Non-resident
2. Do non-residents get the benefit of the Treaty, while computing income under Section 50CA of the Income Tax Act?
Yes, subject to certain conditions, non-residents get the benefit of the Treaty.
