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Valuation of unquoted equity shares

Subject : Accountancy & Financial Management
Month-Year : Sep 2004
Author/s : Chetan A. Karia
Chartered Accountant
Topic : Valuation of unquoted equity shares
Article Details :

Facts :

1. The querist is an individual. The querist along with other family members had promoted a company, ABC Ltd. The said company is a public company, but its shares are not listed and are not quoted on any recognised stock exchange. The querist owns a large number of shares in the said company since 1974.

2. The said shares were sold as part of an understanding with other family members during financial year ending March, 2004. For computing long-term capital gains, indexed cost of acquisition has to be deducted from the sale consideration. In the present case, as shares have been acquired prior to 1-4-1981, the querist has an option to substitute market value of unquoted shares as on the said date for cost of acquisition.

3. The querist has been advised that though yield method of valuation is more appropriate for determination of value of shares in a going concern, in view of decision of the Supreme Court in Gautam Hari Singhania, 207 ITR 1 (SC), break-up value method of valuation of shares is mandatory.

Query :

4. On the above facts, querist seeks opinion as to what is the appropriate method for determination of market value of unquoted equity shares for the purpose of computation of capital gains ?

Opinion :

5. In the case of the querist, market value of unquoted equity shares has to be determined as on 1-4-1981. The company was a going concern on the said date. Further, such valuation has to be for the purpose of computation of capital gains under Income-tax Act, 1961. Under the Act, no rules have been prescribed for determination of market value, and therefore, commercial rules for determination of market value of shares will have to be adopted.

6. The issue of valuation of equity shares was considered in one of the earliest cases in CWT v. Mahadeo Jalan, 86 ITR 621 (SC) and it was laid down as follows :

"An examination of the various aspects of valuation of shares in a limited company would lead us to the following conclusion :

(1) Where the shares in a public limited company are quoted on the stock exchange and there are dealings in them, the price prevailing on the valuation date is the value of the shares.

(2) Where the shares are of a public limited company, which are not quoted on a stock exchange or of a private limited company, the value is determined by reference to the dividends, if any, reflecting the profit-earning capacity on a reasonable com-mercial basis. But, where they do not, then the amount of yield on that basis will determine the value of the shares. .........

(3) In the case of a private limited company also, where the expenses are incurred out of proportion to the commercial venture, they will be added back to the profits of the company in computing the yield. In such companies, the restriction on share transfers will also be taken into considera-tion, as earlier indicated, in arriving at a valuation.

(4) Where the dividend yield and earning method break down by reason of the company’s inability to earn profits and declare dividends, if the set-back is temporary, then it is perhaps possible to take the estimate of the value of the shares before set-back and discount it by a percentage corresponding to the proportionate fall in the price of quoted shares of companies which have suffered similar reverses.

(5) Where the company is ripe for winding up, then the break-up value method determines what would be realised by that process.

(6) As in Attorney-General of Ceylon v. Mackie, a valuation by reference to the assets would be justified, whereas in that case, the fluctuation of profits and uncertainty of the conditions at the date of the valuation prevented any reasonable estimation of prospective profits and dividends."

Therefore for a going concern, yield method was held to be appropriate to determine its market value and normally break-up value is adopted only where the company is ripe for liquidation.

7. In its subsequent judgements in CGT v. Kusumben Mahadevia, 122 ITR 38 (SC), and CGT v. Ambalal Sarabhai, 170 ITR 144 (SC) the Supreme Court reiterated the above principles and held that if the company is a going concern, then only yield method is appropriate method and break-up method cannot be adopted to determine value of unquoted equity shares.

8. As regards judgement of the Supreme Court in Gautam Hari Singhania, 207 ITR 1 (SC), it was rendered in respect of years when rules for valuation of shares were prescribed under Wealth Tax Rules. Judgement in Mahadeo Jalan, though it was rendered in context of wealth tax, dealt with assessment years when no rules were prescribed under Wealth Tax Act or Rules for determination of value of shares. In Gautam Hari Singhania, for the relevant years, Wealth Tax Rules prescribed break-up value method for valuation of shares under Rule 1D and in the said circumstance, it was held that Rules are mandatory, and therefore, unquoted equity shares have to be valued by break-up value method. The Supreme Court distinguished the earlier three judgements in Mahadeo Jalan, Kusumben Mahadevia and Ambalal Sarabhai, on the ground that either no rules were prescribed for the relevant years or that in the later two judgements, issue was under Gift Tax Act where also no rules were prescribed. Therefore, principles laid down by the said three judgements, being Mahadeo Jalan, Kusumben Mahadevia and Ambalal Sarabhai, that value of unquoted equity shares in a company which is a going concern has to be determined by yield method, has not been overruled.

9. In the case of the querist, value of unquoted equity shares has to be determined for computation of capital gains under Income tax Act and no method has been prescribed under the Act or the Rules for such valuation. Further, the company was a going concern, and therefore, in view of the three judgements of the Supreme Court in Mahadeo Jalan, Kusumben Mahadevia and Ambalal Sarabhai, yield method would be appropriate for determination of market value of shares in ABC Ltd. as on 1-4-1981. The issue was considered in a recent judgement in Wg. Cmdr. A. G. Mathews v. CGT, (2004) 134 Taxman 236 (Ker.). In the said case, the Kerala High Court, after considering all the judgements, held that as no rules similar to Rule 1D of Wealth Tax Act were prescribed under Gift Tax Act at the relevant time, valuation has to be carried out by yield method and not by break-up value method.

Conclusion :

10. In view of the above discussion, the querist can determine market value of unquoted equity shares in ABC Ltd. by yield method for determination of capital gains.

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