There are few anti-abuse measures already in place with respect to curbing the practise of avoiding tax through transfer of shares. The Budget has unveiled additional anti-abuse measures in the Income-tax Act, 1961 (Act), as regards the taxability on transfer of unquoted shares below the fair market value (FMV). The amendments proposed in the Budget seek to tax the transactions on account of transfer of unquoted shares, which mitigated tax liability (if transferred below FMV). However, the proposed amendments provide for taxation of the same amount in the hands of two tax payers. This article elaborates the amendments proposed in the Budget and their tax impact with regard to transfer of unquoted shares.
Amendment under the head 'Capital Gains' - new section 50CA proposed to be inserted
In order to curb abusive practices resulting in the avoidance of capital gain tax on transfer of shares, it has been proposed to insert a new section 50CA in the Act to provide for deeming the value of consideration of shares. The said section provides that where consideration for transfer of share of a company (other than quoted share) is less than the FMV of such shares determined in accordance with the manner to be prescribed, the FMV shall be deemed to be the full value of consideration for computing capital gains.
The provisions of section 50CA will be applicable to the transfer of shares of a company other than a quoted share. The term "quoted share" has been explained to mean "the share quoted on any recognised stock exchange with regularity from time to time, where the quotation of such share is based on current transaction made in the ordinary course of business."
Per the extant provisions of the Act, income chargeable under the head 'Capital gains' is computed by taking into account the amount of full value of consideration received or accrued on transfer of a capital asset. In order to ensure that the full value of consideration is not understated, the Act stipulated certain safety mechanisms, such as deeming of stamp duty value as full value of consideration for transfer of immovable property in certain cases. The proposed section 50CA has been introduced to rationalise the extant provisions of the Act to cover in its ambit the transfer of unquoted shares on a value less than the FMV.
Widening the scope of 'Income from other sources' - new clause (x) under section 56(2) proposed to be inserted
The extant provisions of the Act1 contain anti-abuse provisions to safeguard against the acquisition of inter alia shares without consideration or for inadequate consideration by individuals/ HUFs and firms or companies (in certain cases). The said provisions are not attracted in situations where the said transaction is undertaken by other class of tax payers.
In order to curb the practice of receiving shares without consideration or for inadequate consideration, it has been proposed to insert a new clause (x) under section 56(2). This section provides for taxability in the hands of the purchaser of shares2, if the purchase is made without consideration or for consideration less than the FMV of such property. Further, in line with the extant provision of the Act, this provision would only trigger if the difference between the consideration paid and the FMV exceeds INR 50,000. With the introduction of this clause, the scope of the extant provision has been expanded to all the tax payers.
Consequently, clauses (vii) and (viia) of section 56(2) of the Act would not be applicable post 01 April, 2017. Furthermore, in line with the relief available under the extant provisions, amendment has also been proposed to take into account the FMV of the shares as their cost of acquisition in case the provisions of section 56(2)(x) are triggered.
Impact of the above amendments
By way of enactment of section 50CA and section 56(2)(x) in the Act, the government proposes to pluck the probable loss, occurring to the revenue on account of understatement of consideration for transfer of shares. However, in doing so, the Budget has proposed a potential double taxation
Whilst section 50CA proposes to tax the difference between the FMV and the consideration received for transfer of shares as capital gains in the hands of transferor, section 56(2)(x) proposes to tax the same difference in the hands of the transferee of such shares. The aforesaid computational mechanism may lead to taxation of the same amount of consideration in hands of two tax payers i.e., the transferor and transferee.
The same may be understood with the help of the following example.
Seller & Co. (S) acquired 10,000 shares of a private limited company at INR 50 per share. The shares were sold by S to Buyer & Co. (B) at INR 80 per share. The FMV of the shares on the date of transfer was INR 100 per share.3 The impact of the section 50CA and section 56(2)(x) would be as follows.
• Computation of capital gains in the hands of S
Under extant provisions (in INR)
After proposed section 50CA (in INR)
Less : Cost of acquisition4
The sale consideration in the present example, pursuant to introduction of section 50CA, would tantamount to INR 1,000,000 [10,000 shares*INR 100]. The differential amount taxed on account of introduction of section 50CA in the hands of S amounts to INR 200,000. The said amount is being taxed as a result of increase in sale consideration from INR 800,000 to INR 1,000,000.
• Computation of income from other sources in the hands of B
Under extant provisions (in INR)
After proposed section 56(2)(x) (in INR)
FMV of shares (10,000 shares * INR 100)
Less: Actual amount for acquisition of shares (10,000 shares * INR 80)
Income from other sources
The extant provisions of the Act [section 56(2)(viia)] provide for taxing the difference between the FMV of unquoted shares and the purchase consideration under the head 'income from other sources', if the FMV exceeds the purchase consideration. Accordingly, the amount of INR 200,000 would have been taxed in the hands of the transferee under the extant provisions. Similar provision are stipulated under the proposed section 56(2)(x) of the Act, and consequentially the clause (viia) of section 56(2) of the Act is proposed to be made inapplicable with effect from 1 April 2017. Therefore, the amount of INR 200,000 would be taxed in the hands of transferee under the proposed provisions as well.
From the above example, it may be seen as per the extant provisions of the Act, the amount of INR 200,000 was being taxed in the hands of transferee. However, the section 50CA proposes to tax the amount of INR 200,000 in the hands of transferor. Consequently, the amount of INR 200,000 is being taxed in the hands transferor as well as transferee.
The aim to bring anti-abusive measures is to bring into the tax net the amounts, which avoided tax by way of understatement of full value of consideration. Having said so, the taxation as per sections 50CA and 56(2)(x) may result into incidence of double taxation.
The Hon'ble Finance Minister grievously mentioned that India is largely a tax non-compliant society, where the direct tax collection does not commensurate with the income and consumption pattern. Accordingly, the Budget has proposed certain measures to address tax avoidance transactions. The measure to curb transfer of shares at value less than FMV has been introduced with the same intent. However, a situation where enactment of a provision leads to double taxation should be avoided. Furthermore, there should be mechanisms to safeguard genuine taxpayers from such anti-abuse measures.
Section 56(2)(vii) and 56(2)(viia) of the Act.
Section 56(2)(x) proposes to cover money, immovable property and specified movable property (including shares and securities).
For determination of FMV under section 56(2)(x), Rule 11U and 11UA of the Income-tax Rules, 1962 have been prescribed. However, the manner of determining the FMV of shares under section 50CA is yet to be prescribed. Accordingly, for the purpose of this example, it has been assumed that FMV computed under section 50CA and 56(2)(x) will be the same.
Computation of capital gains has been made assuming it to be short term