Sudden prohibition for CA Valuers

By Yutika Lohia, (yutika@vinodkothari.com) (finserv@vinodkothari.com)

Introduction

The income tax laws of our country have witnessed a lot vicissitudes over the years. Responding to the changing reforms as well as practices, the law makers have always tried to pace up with the dynamic economy. Chartered Accountants, in India, are widely accepted as tax professionals and in that capacity they play a very important role in the comprehending the income tax laws for the commoners. But a recent change by the IT Department would certainly not please the CA fraternity in the country.

The change has been brought in Rule 11UA of the Income Tax Rules which deals with the valuation of various assets for the purpose of sections 56(2)(viib) or 56(2)(x) of the Income Tax Act. While section 56(2)(x) deals with charging of income tax under the head other sources where there is a gain due to difference in fair value of an asset and the transaction value of an asset transferred, section 56(viib) provides for charging of tax under the head other sources, where any closely held company issues shares at more than fair value of the asset.

Rule 11UA has been divided into two sub rules which provides as follows:

  • Sub rule (1) of Rule 11UA determines the fair market value of a property, other than immovable property
  • Sub rule (2) of Rule 11UA determines the fair market value of unquoted shares for the purpose of section 56 (2)(viib) of the I.T Act, 1961
  1. Clause (a) of sub rule (2) of Rule 11UA deals with adjusted net asset value (NAV) method. Certification of such valuation is silent in the Rules.
  2. Clause (b) of sub rule (2) of Rule 11UA deals with the discounted cash flow (DCF) approach

DCF model indicates the fair market value of a business based on the value of projected cash flows that the business is expected to generate in future.

Notification issued by CBDT

Central Board of Direct Taxes (CBDT) vide its Notification[1], no -23/2018/F.No.370142/5/2018-TPL dated 24th May, 2018 has made alterations in Rule 11UA(2)(b), which allowed merchant bankers and chartered accountants for carrying out valuation of the equity shares using discounted cash flow method. The notification has withdrawn the power assigned to CAs for determining fair market value of unquoted shares under Discounted cash flow (DCF) method for the purpose of section 56(2)(viib). The said notification has been made effective from 24th May, 2018.

The notification has also removed the definition of the term ‘accountant’ as defined under Rule 11U, which defines the meaning of expression used in determination of fair market value for Rule 11UA.

Therefore, if a closely held company is desirous of issuing further shares and wants to get it valued under DCF, then it will have to get it done by merchant bankers only.

The table below shows the pre and post scenario of Rule 11UA pursuant to the amendment:

Prior to Amendment Post Amendment
Rule 11U defined “accountant“ under clause (a)

“(i) for the purposes of sub-rule (2) of rule 11UA, means a fellow of the Institute of Chartered Accountants of India within the meaning of the Chartered Accountants Act, 1949 (38 of 1949) who is not appointed by the company as an auditor under section 44AB of the Act or under section 224 of the Companies Act, 1956 (1 of 1956); and

(ii)in any other case, shall have the same meaning as assigned to it in the Explanation below sub-section (2) of section 288 of the Act;”

 

Clause (a) of Rule 11U has been omitted.

 

(i)for the purposes of sub-rule (2) of rule 11UA, means a fellow of the Institute of Chartered Accountants of India within the meaning of the Chartered Accountants Act, 1949 (38 of 1949) who is not appointed by the company as an auditor under section 44AB of the Act or under section 224 of the Companies Act, 1956 (1 of 1956); and

(ii)in any other case, shall have the same meaning as assigned to it in the Explanation below sub-section (2) of section 288 of the Act;”

 

As per Rule 11UA, sub rule (2), in clause (b), accountants and merchant bankers were allowed to value unquoted share by discounted cash flow approach.

 

(b)the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method

The word “accountant” has been omitted and now only merchant bankers are eligible to value unquoted share by discounted cash flow approach.

 

(b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.

 

Conclusion

The above amendment is only with respect to the fresh issue of shares by the company using the DCF approach. However, accountants may still continue to value unquoted equity shares by adjusted NAV approach as per sub rule (1) and sub rule (2) clause (a) of Rule 11UA.

Further, it is to be noted that the word “accountant” is still used in Rule 11UA sub rule (1), whereas the definition of the term has been omitted from the rules. Therefore, the apparent question that arises is with respect to the meaning of the term “accountant”. In this regard, explanation (2) to section 288 of the Income Act can be referred to. Extracts provided below:

Explanation to sub-section (2) of section 288 of the Act;

In this section, “accountant” means a chartered accountant as defined in clause (b) of sub-section (1) of section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a valid certificate of practice under sub-section (1) of section 6 of that Act, but does not include [except for the purposes of representing the assessee under sub-section (1)]

If one was to compare the professional charges and availability of Chartered Accountants and Merchant Banker, definitely CA’s will hold an upper hand in terms of their availability and economical charges. Also, the ratio of Merchant Bankers to the companies falling under the ambit of Rule 11UA is very wide keeping in mind the strength of Merchant Bankers in the market. This amendment will also increase the cost burden of the company for performing valuation of their fresh issue.

There is hue and cry in the CA fraternity and the Institute of Chartered Accountants of India (ICAI) has been taking efforts to subdue the notification and have also made a written representation to the CBDT[2] for withdrawing the notification.


[1] https://www.incometaxindia.gov.in/communications/notification/notification23_2018.pdf

[2] https://resource.cdn.icai.org/50361dtc300518.pdf

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