When is the valuation of shares required?

One of the important reasons is when you are about to sell your business and want to know your business value.

When you approach your bank for a loan based on share as security.

For tax assessments under the wealth of tax or gift tax acts.

How to choose the share valuation method

Assets Approach

Income Approach

Market Approach

What are Methods of Share Valuation

Asset-Based

Income-Based

Market-Based 

Earnings Yield 

Dividend Yield 

Income Tax Rule 11UA deals with the valuation of unquoted equity shares. As per Clause (b) of Sub-Rule 2 of Rule 11UA earlier, merchant banker and Chartered Accountant were allowed to do valuation of unquoted equity shares under Discounted Free Cash Flow method but vide  Notification No. 23/2018 dated 24th May 2018, it is provided that now only merchant banker can do valuation of unquoted equity shares under Discounted Free Cash Flow method and Chartered Accountants are no more allowed to do the same.

Hence, after this amendment, things got puzzled up for everyone as of,

When an owner of Unquoted equity shares("Shares") in a Company transfers the shares to any person, he is required to pay Capital Gain tax on the difference between the sale consideration received by him and the cost of acquisition of such shares (or the inflation-indexed cost, wherever applicable). It is important to check if the "Sale consideration" that he receives from the buyer is at least equal to or more than the " Fair Market Value  " ("FMV") as defined under Rule 11UA of The Income Tax Rules of the shares sought to be transferred.

As per Rule 11UA of the Income-tax Rules, 1962, the FMV of unquoted shares is to be determined as under:

The fair market value of unquoted equity shares =

where,

 A= book value of all the assets (other than jewelry, artistic work, shares, securities, and immovable property) in the balance sheet as reduced by, -

• any amount of income-tax paid if any, less the amount of income-tax refund claimed if any; and
• any amount is shown as an asset including the unamortized amount of deferred expenditure, which does not represent the value of any asset;

B = the price which the jewelry and artwork would fetch if sold in the open market based on the valuation report obtained from a registered valuer;

 C = fair market value of shares and securities as determined in the manner provided in this rule;

 D = the value adopted or assessed or assessable by any authority of the Government for payment of stamp duty in respect of the immovable property;

L= book value of liabilities shown in the balance sheet, but not including the following amounts, namely: -

• the paid-up capital in respect of equity shares;
• the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
• reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
• any amount representing provision for taxation, other than the amount of income-tax paid if any, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable concerning the book profits following the law applicable to it;
• any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
• any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PV= the paid-up value of such equity shares;

PE = total amount of paid-up equity share capital as shown in the balance sheet;

a) the fair market value of unquoted equity shares =

            where,

A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

L = book value of liabilities shown in the balance sheet, but not including the following amounts, namely: 

• the paid-up capital in respect of equity shares;
• the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
• reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
• any amount representing provision for taxation, other than the amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable concerning the book profits following the law applicable to that;
• any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
• any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

PE = total amount of paid-up equity share capital as shown in the balance sheet;

          PV = the paid-up value of such equity shares;

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

Conclusion- With effect from the 1st day of April 2018 where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares. FMV does not imply the actual market value of the shares at which shares may be transacted between parties. It is the value of shares as determined based on the book value of the assets and liabilities of the company.