Taxation of Special Income Under

Section – 56(2)(vii) & (viia) including
Valuation Rules

Presented by:

CA Prashant Kapoor
Mergers and Acquisitions - Tax
July 10, 2010

Contents
1

Background

2

Section 56(2)(vii) - Analysis

3

Section 56(2)(vii) - Issues

4

Section 56(2)(viia) - Analysis

5

Section 56(2)(viia) - Issues

6

Valuation Rules

2

Background
3

Income not included under any other head. if it is not chargeable to income-tax under any of the heads specified in section 14. and .Background – Income from Other Sources Section 56(1) reads as under: “Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”. 1922.Income included in the total income of an assessee. Any income chargeable under a specific head can be charged only under that head and no part of that income can be charged again under section 56 4 . items A to E”  The above charging section is same as section 12 of the Income-tax Act.  Two conditions are required to be satisfied for any income to be chargeable under the head income from other sources: .

Section 56(2)(vii) 5 .

from any person or persons on or after the 1st day of October. the aggregate FMV of which exceeds fifty thousand rupees. in any previous year.Section 56(2)(vii) Section 56(2)(vii) reads as under: “where an individual or a HUF receives. the stamp duty value of which exceeds fifty thousand rupees. the stamp duty value of such property.— (i) without consideration. the Assessing Officer may refer the valuation of such property to a Valuation Officer. (c) any property. (b) any immovable property. the whole of the aggregate FMV of such property. without consideration. 2009. apply in relation to the stamp duty value of such property for the purpose of sub-clause (b) as they apply for valuation of capital asset under those sections. without consideration. as far as may be. other than immovable property. the aggregate value of which exceeds fifty thousand rupees. (ii) for a consideration which is less than the aggregate FMV of the property by an amount exceeding fifty thousand rupees. and the provisions of section 50C and sub-section (15) of section 155 shall.— (a) any sum of money. the whole of the aggregate value of such sum. 6 . the aggregate FMV of such property as exceeds such consideration : Provided that where the stamp duty value of immovable property as referred to in sub-clause (b) is disputed by the assessee on grounds mentioned in sub-section (2) of section 50C.

means the value determined in accordance with the method as may be prescribed. or (ix) bullion. (viii) any work of art. or (d) in contemplation of death of the payer or donor.— (a) “assessable” shall have the meaning assigned to it in the Explanation 2 to sub-section (2) of section 50C. (f) “stamp duty value” means the value adopted or assessed or assessable by any authority of the Central Government or a State Government for the purpose of payment of stamp duty in respect of an immovable property. (vii) sculptures. namely:— (i) immovable property being land or building or both.” 7 . or (e) from any local authority as defined in the Explanation to clause (20) of section 10. or (c) under a will or by way of inheritance. as the case may be. or (g) from any trust or institution registered under section 12AA.Section 56(2)(vii) Provided further that this clause shall not apply to any sum of money or any property received— (a) from any relative. (c) “jewellery” shall have the meaning assigned to it in the Explanation to sub-clause (ii) of clause (14) of section 2. (vi) paintings. (e) “relative” shall have the meaning assigned to it in the Explanation to clause (vi) of sub-section (2) of this section. (iii) jewellery. (d) “property” means the following capital asset of the assessee. Explanation. (v) drawings.—For the purposes of this clause. or (b) on the occasion of the marriage of the individual. (ii) shares and securities. (b) “FMV” of a property. or (f) 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. (iv) archaeological collections. other than an immovable property.

C.” 8 . 2009 and will. It is. The intent is not to tax the transactions entered into in the normal course of business or trade. 2010 explains the rationale behind Section 56(2)(vii) as under: “The provisions of section 56(2)(vii) were introduced as a counter evasion mechanism to prevent laundering of unaccounted income under the garb of gifts. therefore. In several cases of immovable property transactions. which results in a taxable differential. It is. particularly after abolition of the Gift Tax Act. raw material and consumable stores of any business of such recipient. apply in relation to the assessment year 2010-11 and subsequent years. These amendments are proposed to take effect retrospectively from 1st October. proposed to amend the definition of property so as to provide that section 56(2)(vii) will have application to the ‘property’ which is in the nature of a capital asset of the recipient and therefore would not apply to stock-in-trade. The provisions were intended to extend the tax net to such transactions in kind. therefore. accordingly. the profits of which are taxable under specific head of income. proposed to amend clause (vii) of section 56(2) so as to provide that it would apply only if the immovable property is received without any consideration and to remove the stipulation regarding transactions involving cases of inadequate consideration in respect of immovable property.Section 56(2)(vii): Memorandum explaining provisions The Memorandum to Finance Bill. there is a time gap between the booking of a property and the receipt of such property on registration.

 Exclusions .000.Any gift received: - From any relative - On the occasion of the marriage of the individual - Under a will or by way of inheritance.Applicability & Exclusions  Applicable to: - Money or moveable property or immovable property received by Individual / HUF. - In contemplation of death of the payer.50. and - Value of above exceeds Rs. or From any trust or institution registered under section 12AA.Section 56(2)(vii): In Summary . 9 . - From any local authority as defined under 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 section 10 (23C).

FMV minus ‘x’). the consideration (say INR ‘x’) is less than the aggregate FMV of such property by an amount exceeding Rs.e.Section 56(2)(vii): Computation Mechanism Taxability under Section 56(2)(vii) Situation 1: Any sum of money exceeding Rs. Situation 3: Where there is inadequate consideration for a moveable property i.50.50.e.000 Taxable income: Aggregate FMV of such property exceeding the consideration (i.000 without consideration– Taxable Income: Entire sum Situation 2: Where immovable property with a stamp duty value exceeding Rs.000 is received without considerationTaxable income: Stamp duty value. 10 .50.

Section 56(2)(vii) – Issues 11 .

e. stamp duty value as provided in section 50C would be chargeable to tax in the hands of transferor as Capital Gains and as Income from Other Sources in the hands of the recipient under section 56) What would be the position when individual transfers the money or property to HUF or vice versa? Whether the term ‘relative’ is to be interpreted by the relation of Karta or all members of HUF including all female members? Whether transfer of money or property from a private trust to the individual beneficiaries would be taxable in the hands of beneficiaries? Whether any amount given free of interest without any consideration will come within the purview of the section 56(2) (vii)? 12 . the same amount would become taxable in the hands of the transferor and the recipient (i.Section 56(2)(vii): Issues In case of immovable properties.

Section 56(2)(viia) 13 .

the aggregate fair market value of such property as exceeds such consideration: Provided that this clause shall not apply to any such property received by way of a transaction not regarded as transfer under clause (via) or clause (vic) or clause (vicb) or clause (vid) or clause (vii) of section 47. Explanation — For the purposes of this clause.” 1 As inserted by Finance Act 2010 14 . 2010. “fair market value” of a property. being shares of a company not being a company in which the public are substantially interested. the aggregate fair market value of which exceeds fifty thousand rupees. any property. receives. the whole of the aggregate fair market value of such property. being shares of a company not being a company in which the public are substantially interested. on or after the 1st day of June.Section 56(2)(viia) Section 56(2)(viia)1 reads as under: “Where a firm or a company not being a company in which the public are substantially interested.— (i) without consideration. (ii) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees. from any person or persons. in any previous year. shall have the meaning assigned to it in the Explanation to clause (vii).

(vic). However. Section 2(18) provides the definition of a company in which the public are substantially interested. any sum of money or any property in kind which is received without consideration or for inadequate consideration (in excess of the prescribed limit of Rs. instead of an individual or an HUF.000/-) by an individual or an HUF is chargeable to income tax in the hands of recipient under the head ‘income from other sources’.” 15 . receipts from relatives or on the occasion of marriage or under a will are outside the scope of this provision…… These are anti-abuse provisions which are currently applicable only if an individual or an HUF is the recipient. 50. It is also proposed to exclude the transactions undertaken for business reorganization. Therefore. amalgamation and demerger which are not regarded as transfer under clauses (via). without consideration or at a price lower than the fair market value does not attract the anti-abuse provision. (vid) and (vii) of section 47 of the Act. it is proposed to amend section 56 to also include within its ambit transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where the recipient is a firm or a company (not being a company in which public are substantially interested). In order to prevent the practice of transferring unlisted shares at prices much below their fair market value. (vicb).Section 56(2)(viia): Memorandum explaining provisions The Memorandum to FB 2010 explains the rationale behind Section 56(2)(viia) as under: “Under the existing provisions of section 56(2)(vii). transfer of shares of a company to a firm or a company.

Section 56(2)(viia): Rationale The amendment proposes to cover the transfer of shares without / for inadequate consideration. 788 of 2008). We understand the amendment has come in view of the two advance rulings in the case of Amiantit International Holding Limited (AAR No. the charging provision under section 45 cannot be invoked to charge the capital gains tax. wherein it was decided that transfer of shares without any consideration would result in failure of computation provisions in section 48 and consequently. 817 of 2009) and Dana Corporation (AAR No. 16 .

the income could not be brought in the purview of tax net in India.  Relying on the ratio of the judgment in case of B.  Section 92 of the Act is not a charging provision but a provision providing computational methodology.  A separate holding company (‘DHC’) was formed at the helm of the group to take over the assets and liabilities of the taxpayer. the TP provisions contained in Section 92 would not be applicable. the AAR ruled that since in the present case there was no ‘consideration’ as prescribed in Section 48. Srinivasa Setty. C.  If by application of Section 45 read with Section 48.  The AAR observed that the profit or gain envisaged by Section 45 of the Act should be a distinct component of the transaction and should not be computed on a notional or hypothetical basis. arose to the taxpayer on account of transfer of shares in the Indian companies and whether the ingredient of ‘full value of consideration’ as contemplated in Section 48 of the Act was present ? Whether TP laws are applicable to the aforesaid transaction? The taxpayer’s liabilities assumed by DHC could not be legitimately treated as consideration nor could it be adopted as a measure of consideration for the transfer of shares.Section 56(2)(viia): Dana Corporation Facts  The taxpayer was a company registered in USA and was holding shares of 3 Indian group companies in addition to group companies across the globe. Further. Issues   AAR’s  Ruling Whether any profit or gain within the meaning of Section 45 of the Act. there could be no capital gains chargeable to tax under. 17 .  The taxpayer had filed for bankruptcy under the Bankruptcy code of USA.  Per the reorganization plan submitted under the aforesaid proceedings. the taxpayer transferred its shares of Indian group companies to its subsidiary entities in USA. an independent private equity concern infused funds into DHC for exchange of DHC’s shares.

 As a part of group restructuring process. Since applicant did not derive any profit or gain in the form of money or money's worth or nothing capable of being turned into money has accrued or arisen to the applicant on the date of transfer. It was wholly owned by South Arabian Amiantit Company.C. the applicant proposes to contribute the shares of the Indian company without any consideration along with non-European investments to its Cyprus subsidiary under a ‘Contribution Agreement’. the applicant was not liable to tax in India.  The income in the sense of profit and gain should be real but not hypothetical income. 18 .  The applicant holds 70% of the equity shares in an Indian operating company and also has a WOS in Cyprus (an investment company). The Supreme Court in the case of B. Srinivasa Setty had explained the scope of both the above provisions. the charging provision fails. is required to withhold tax as per the provisions of section 195 of the Act? AAR’s On liability to tax in India Ruling  When the computation provision cannot be applied. On withholding tax  No liability to withhold tax under section 195 of the Act since income is not chargeable to tax. Issues  Whether the applicant is liable to tax in India on the proposed contribution of shares of an Indian company?  Whether the proposed contribution of shares by the applicant to the Cyprus company attracts the transfer pricing provisions of section 92 to 92F of the Act?  Whether the Cyprus company. which held shares of various group entities.Section 56(2)(viia): Amiantit International Holding Limited Facts  The taxpayer is an investment company incorporated in the Kingdom of Bahrain and is having investments in various Asian. On the applicability of transfer pricing provisions  The AAR relied on the case of Dana Corporation and held that if income is not chargeable under section 45 read with section 48 of the Act the transfer pricing provisions under section 92 of the Act are not applicable. European as well as Latin American companies.

the cost of acquisition of such property shall be deemed to be the value which has been taken into account for the purposes of clause (vii) and clause (viia)” Thus. the value of which has been subject to incometax under clause (vii) and clause (viia) of sub-section (2) of section 56.Section 56(2)(viia): Corresponding amendments Section 2(24)(xv) – Definition of “Income” expanded “Income includes any sum of money or value of property referred to in ………. the FMV of the shares as per Section 56(2) to be considered as cost of acquisition in the hands of recipient of shares 19 . clause (viia) of sub-section (2) of section 56” Section 49(4) – Cost of acquisition in certain cases “Where the capital gain arises from the transfer of a property.

 Transferor / Donor  Any person (R / NR) Receipt of shares (physical or demat / equity or preference)  Transferee / Recipient On or after 1 June 2010    Firm / Closely held Co. Receipt of shares – Should be on or after 1 June 2010. (c ) Shares could be of an Indian / Foreign Co. 20 . (b) Can be a R/NR Transferor – (a) Can be any “Person”.Section 56(2)(viia): Applicability  Shares in a closely held Indian / Foreign co. (b) Could be equity / preference shares. in which public are substantially interested. in which public are substantially interested. Receipt of shares – Shares should not be in a Co. (R / NR) Recipient – (a) Needs to be a Firm or a Co. other than a Co. (b) Can be a R/NR Receipt of shares – (a) Could be in demat or physical form.

under a scheme of demerger 47(vii) Receipt of shares in the amalgamated Co. by the shareholders of the demerged Co. from the amalgamated Foreign Co. in a scheme of demerger 47(vicb) Receipt of shares in case of business re-organization of a co-operative bank 47(vid) Receipt of shares in the resulting Co. by resulting Foreign Co. in a scheme of amalgamation 47(vic) Receipt of shares in an Indian Co. from the demerged Foreign Co. under a scheme of amalgamation These exclusions are not applicable if shares received by an Individual and HUF 21 .Section 56(2)(viia): Exclusions Transactions excluded from the applicability of Section 56(2)(viia) Section Nature of transaction 47(via) Receipt of shares in an Indian Co. by amalgamating Foreign Co. by the shareholders of the amalgamating Co.

e.e.000 and there is NIL consideration – Taxable Income: Aggregate FMV of the shares Situation 2: Where there is inadequate consideration i. the consideration (say INR ‘x’) is less than the aggregate FMV of the shares by an amount exceeding INR 50.Section 56(2)(viia): Computation Mechanism Taxability under Section 56(2)(viia) Situation 1: Where FMV of shares exceeds INR 50. FMV minus ‘x’). As per recent CBDT notification. FMV of unquoted shares to be determined as under  Equity shares –’Book value’ computed in the specified manner  Other shares – Price which such shares will fetch in the open market as supported by a valuation report of a Merchant Banker or Chartered Accountant 22 .000 Taxable income: Aggregate FMV of the shares exceeding the consideration (i.

Issues 23 .Section 56(2)(viia).

Section 56(2)(viia): Issues Receipt of “newly allotted” shares/ warrants/ debentures Whether issue of fresh shares (bonus shares / rights shares / shares allotted in a preferential issue) at a price lower than the FMV would attract Section 56(2)(viia)? Whether issue of warrants (which entitles the investor to subscribe for equity shares) will attract Section 56(2) (viia)? Whether issue of debentures (whether non-convertible or partly convertible or fully convertible) will attract Section 56(2)(viia)? Whether receipt of equity shares on conversion of preference shares / debentures attract Section 56(2)(viia)? Whether forfeiture of shares or a subsequent re-issue of forfeited shares by a Co. will attract Section 56(2)(viia)? 24 .

whether Section 56(2)(viia) would apply in the hands of amalgamated / resulting / transferee company in case of receipt of shares by them which were held as investment by the amalgamating / demerged / transferor company? Whether Section 56(2)(viia) can apply to shares received on liquidation? Whether receipt of shares by companies under a family settlement / family succession would attract Section 56(2) (viia)? Whether contribution of shares by a Partner as its capital in the firm would attract Section 56(2)(viia)? Does it make a difference if a firm is an LLP formed under Limited Liability Partnership Act. 2008? Does it make any difference if the firm is an Indian registered firm or is a foreign partnership? 25 .Section 56(2)(viia): Issues Business restructuring / re-organisation Whether buy-back of shares / reduction of capital at a price below the FMV of such shares would attract Section 56(2) (viia)? In case of an amalgamation / de-merger / slump sale.

Section 56(2)(viia): Issues Trusts Will Section 56(2)(viia) apply if shares are settled on a trust. if the beneficiary of the trust is a firm or a company? Will Section 56(2)(viia) apply if shares are distributed by a trust to its beneficiaries who are firms or companies? 26 .

Section 56(2)(viia): Issues Threshold limit of INR 50. should be considered or should one aggregate shares of all companies received during the year? For determining the taxable amount.000 whether receipt of shares of each individual Co. should one aggregate transactions of inadequate / Nil consideration or.000 . aggregate all transactions including transactions with adequate consideration? 27 .Computation For meeting the threshold limit of INR 50.

Valuation Rules 28 .

Section 56(2)(vii) & (viia): Valuation Rules – Notification no. If shares and not traded on the valuation date then the lowest price of such shares and securities on any recognized stock exchange on a date immediately preceding the valuation date when such shares and securities were traded on such stock exchange Valuation date shall be the date on which the respective property is received by the assessee 29 . FMV will be: Not transacted through Stock Exchange i. 23/2010 dated 7 April 2010 Quoted Shares and Securities Transacted through Stock Exchange FMV will be transaction value as recorded in such stock exchange. the lowest price of such shares and securities on any recognized stock exchange on the valuation date ii.

Section 56(2)(vii) & (viia): Valuation Rules – Notification no. 30 . PV = Paid up value of such equity shares. 23/2010 dated 7 April 2010 Unquoted Shares and Securities FMV on the valuation date shall be: FMV = (A-L) * (PV) (PE) Where A is determined as under: Where L is determined as under: Equity Shares PE = Paid up equity share capital as shown in B/S.

Sculptures or any work of art The FMV of above property received shall be estimated to be the price which such jewellery would fetch if sold in the open market on the valuation date. n case the above property is received by the way of purchase from a registered dealer on the valuation date then the FMV shall be the invoice value of such property. The taxpayer may obtain a report from a merchant banker or an accountant in respect of such valuation.000. In case the above property is received by any other mode and its value exceeds Rs. Drawings. then assessee may obtain the report of registered valuer in respect of the price it would fetch if sold in the open market on the valuation date.Section 56(2)(vii) & (viia): Valuation Rules – Notification no. 31 . Jewellery and Archaeological collection.50. Paintings. 23/2010 dated 7 April 2010 Unquoted Shares and Securities Any other Security FMV shall be estimated selling price which such shares would fetch if sold in the open market on the valuation date.

Glossary of Terms B/S: Balance Sheet CBDT : Central Board of Direct Taxes COA : Cost of Acquisition Co. : Company DTAA: Double Taxation Avoidance Agreement FB : Finance Bill FMV : Fair Market Value HUF : Hindu Undivided Family INR : Indian National Rupees LLP : Limited Liability Partnership NR : Non-Resident R: Resident TP: Transfer Pricing 32 .

Thank You for Your Interest and Attention!!! For any questions.com 33 . please feel free to contact: Prashant Kapoor. M&A .Tax Director Direct: +91 124 334 5318 prashantkapoor@kpmg.