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Valuation rules prescribed under tax provision plays very important role not only in determining the tax liability but also on the conclusion of the transaction itself. The importance of valuation is typically appreciated from the perspective of taxing the differential value under Capital gains. However, the impact valuation holds in computing tax under 'Income from Other Sources' is often underestimated.
Keeping the above in mind, there are valuation rules which may require relook and what better time than upcoming budget!
We would anticipate the government to streamline few of the valuation rules which ultimately will have two-fold benefit - (a) the taxpayers will have clarity on the relevant provisions and tax certainty, and (b) reduction in cost and time spent on appeals for both the taxpayers and the Department.
Few of the key areas where valuation rules may require a relook:
The FMV under Section 55(2)(ac) for long term capital assets in the nature of listed equity shares of a Company, acquired prior to 1st February 2018 (Cut-off date) is defined as the highest price quoted on stock exchange as of 31st January 2018. In case of a merger or demerger that happens on or after 1st February 2018, ambiguity arises on valuation of the shares transferred subsequently but acquired prior to cut-off date.
Consider a taxpayer who had acquired shares of a Listed Company 'ABC Ltd.' on or before 31st January 2018. In the end of 2018, ABC Limited merged with another Listed Company 'PQR Ltd.' If the taxpayer transfers the share in 2019, it is obscure on how the fair valuation on 31st January 2018 is to be considered to determine cost of acquisition. Since both the Companies were listed as on 31st January 2018, should the higher of their prices be considered? Similarly there is lack of clarity in case of demerger that happens on or after 1st February 2018 and the taxpayer had held the shares prior to cut-off date. Hence, a clarification on this aspect will be a welcome step to rule out any ambiguity.
Section 50B deals with capital gains taxation on slump sale and is based on Rule 11UAE for valuation. In case where transfer happens at book value, the consideration is deemed as the sum of fair value of individual assets. This deemed sale consideration is introduced to curtail the aggressive tax planning on business transfer at tax net worth to avoid taxes. In order to avoid the genuine distress sale out of this deemed provision, the department may consider that deemed sale consideration shall be only applicable in case of related party transaction. Further, it is discriminatory to not give benefit of indexation in such cases where the Undertakings constituting a business activity are long term (held for more than 36 months). Indexation is used to adjust the purchase price of an investment to reflect the effect of inflation on it. Therefore, a suitable amendment to Section 50B(2) to provide indexation benefit in line with second proviso to Section 48 for valuing assets under Rule 11UAE(1) will be of significant benefit.
The real-estate sector is still recovering from major setback amidst the ongoing pandemic. This is further evidenced by RBI having come up with loan restructuring programs twice in the last two years. Furthermore, it is clearly evident that third wave of Pandemic will peak in 1st quarter of 2022, bringing more bad news for real estate sector. Section 43CA of the Income Tax Act, 1961 ('ITA') provides for deeming stamp duty value (SDV) as sale consideration for transfer of real-estate inventory, if SDV exceeded the actual consideration. Essentially, this deems SDV as purchase consideration for buyer under Section 56(2)(x) of ITA. A safe harbor of 20% is granted in case of variation between actual consideration and SDV. This relief was provided, intending to boost the demand in real estate sectors by easing liquidation of unsold stock particularly to home buyers. It is, however, subject to fulfilling the following conditions - a) Sale to occur between 12th November 2020 to 30th June 2021, b) Sale consideration capped to INR 2 Crores and c) the unit to be first time residential allotment. It will be of major boost to sector to extend the 20% beneficial threshold till 31st December 2022 and to increase the monetary limits for sale.
Receipt of Immoveable property(ies) for a consideration lower than the SDV are subject to tolerance band of 5% of consideration or INR 50,000 whichever is higher, following guideline valuation principles. In case of property referred under Section 43CA, the tolerance band of 20% applies instead of 5%. However, incase of receipt of property other than immoveable property and difference between consideration and FMV exceeds INR 50,000, then FMV shall be deemed as consideration in the hands of the buyer. A straight-forward presumption as to a transaction being undervalued if the differential value exceeds INR 50,000 individually or in aggregate is inequitable as there could be influencing factors like stressed sale (including pandemic scenario), bulk discounts, special price for relationship building, obsolete products where historic cost will not reflect economic value, contractual terms like trade discount upon timely settlement of dues. Such genuine business transactions with no intent of tax avoidance should be considered from economic or commercial front. Hence, it is suggested to suitably amend Section 56(2)(x) of ITA to provide for increase in the threshold limit of INR 50,000 to higher limit say INR 200,000 for the applicability of the section.
Section 45(5A) of ITA governs capital gains arising from sale of Land or Building or both under Joint Development Agreement (JDA), which deems SDV as sale consideration in case of inadequate actual consideration, similar to provisions of Section 50C. The relief provision of Section 50C of ITA specify wherein an assessee who is aggrieved that SDV adopted is higher than the FMV on date of transfer, can get the case referred by AO to VO. This remedy is unavailable incase of JDA transaction. Therefore, extending principles of Section 50C completely to Section 45(5A) would enable genuine cases of the assessee being heard, thus ensuring fairness in valuation in case of JDA transaction.
Overall, to improve the business conditions and ease of doing business in India, it will be worth to relook the above valuation provisions and suitably amend the same, thus lessening the burden for taxpayers. This will help to increase the trust factor and achieving a more transparent and effective system in place. A proactive address by the Government on the needs of assessee is the essential requirement and expectation. Hope the upcoming Budget considers and aligns the income tax valuation principles with business reality.
This article was originally published on Taxmann.