India Mulls Oversight on Sales of Unquoted Shares for Tax

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By Siri Bulusu

India’s tax authority has published draft rules prescribing how the value of unquoted shares will be calculated for tax purposes, now set to include government oversight over transactions between private parties while expanding the reach of capital gains tax.

India’s Central Board of Direct Taxes issued the draft rules May 5, stating that when determining capital gains tax after April 1, 2017, “book value” will no longer be the accepted rate at which unquoted shares—as well as securities, art work, jewelry or unmovable property—can be valued for tax purposes, if it is found to be lower than the “fair market value.”

The CBDT is consulting on its draft rules on how to calculate fair market value until May 19, 2017.

“This rule will create trouble since it basically assumes anything outside of fair market value is a disingenuous transaction,” Uday Ved, a Mumbai-based chartered accountant, told Bloomberg BNA May 6.

The Finance Act 2017 amended two sections relating to capital gains tax, first in relation to the seller, stating that if unquoted shares are sold for a price below market value, the difference between the sale price and the market price will be taxed at either 10 or 20 percent as capital gains. The corresponding provision relating to the buyer has also been changed to state that any difference between purchasing price and fair market value will be taxed as ordinary income—which is normally a rate of 33 percent.

Jewelry will need to be evaluated by a government-approved expert and immovable property will be valued at the the notarized deed value. The fair market value of unquoted shares will be calculated using a method set forth in the draft rules, which practitioners say will certainly drive the value up.

For example, if a U.S.-based company is selling shares to a U.K.-based company upon a fair value basis, tax authorities can disagree with the price of the shares, and make “tweaks” to increase the fair market valuation and make a big tax demand, say tax practitioners.

Ved said the new rules will be a burden since related parties often transact under favorable terms and unrelated parties were previously not subject to scrutiny since companies often negotiate deals for below market value transfers of shares.

Black Money

The new draft rule is intended to undercut the flow of black money circulating through India, but practitioners say the prescribed method for coming to fair market value will have a huge impact on genuine transactions.

“This method is draconian, because any small adjustment in the calculation process will result in a big tax demand, so I don’t think it’s a good provision—it should’ve been restricted to earnings or book value,” Rajesh Gandhi, tax partner at Deloitte India, told Bloomberg BNA May 6.

Tax practitioners say the method by which fair market value must be calculated will increase tax liability for both the seller and the buyer, creating a double tax demand on the same transaction.

“Many court cases previously upheld that two private parties can decide their own price and a third party cannot come in and pass judgment on the transaction, but that changes now under the amendments to the Finance Act,” Gandhi said.

Gandhi said the amendments will increase litigation for companies since India’s tax treaties don’t issue any guidance for valuations.

“This will certainly increase litigation, so companies should make strong representations,” Gandhi said.

To contact the reporter on this story: Siri Bulusu at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

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