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

Section 56(2)(vii) - Analysis

Section 56(2)(vii) - Issues

Section 56(2)(viia) - Analysis

Section 56(2)(viia) - Issues

Valuation Rules

Background
3

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, if it is not chargeable to
income-tax under any of the heads specified in section 14, items A to E

The above charging section is same as section 12 of the Income-tax Act, 1922.
Two conditions are required to be satisfied for any income to be chargeable under the head
income from other sources: - Income not included under any other head; and
- 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
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Section 56(2)(vii)
5

Section 56(2)(vii)
Section 56(2)(vii) reads as under:
where an individual or a HUF receives, in any previous year, from any person or persons on or after the 1st day of October,
2009,
(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the
aggregate value of such sum;
(b) any immovable property, without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp
duty value of such property;
(c) any property, other than immovable property,
(i) without consideration, the aggregate FMV of which exceeds fifty thousand rupees, the whole of the aggregate FMV
of such property;
(ii) for a consideration which is less than the aggregate FMV of the property by an amount exceeding fifty thousand
rupees, 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, the Assessing Officer may refer the valuation of such
property to a Valuation Officer, and the provisions of section 50C and sub-section (15) of section 155 shall, as far as may
be, 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.

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; or (b) on the occasion of the marriage of the individual; or (c) under a will or by way of inheritance; or
(d) in contemplation of death of the payer or donor, as the case may be; or (e) from any local authority as defined in the
Explanation to clause (20) of section 10; 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; or (g) from any trust or
institution registered under section 12AA.

Explanation.For the purposes of this clause,

(a) assessable shall have the meaning assigned to it in the Explanation 2 to sub-section (2) of section 50C;
(b) FMV of a property, other than an immovable property, means the value determined in accordance with the method as
may be prescribed;
(c) jewellery shall have the meaning assigned to it in the Explanation to sub-clause (ii) of clause (14) of section 2;
(d) property means the following capital asset of the assessee, namely:
(i) immovable property being land or building or both; (ii) shares and securities; (iii) jewellery;
(iv) archaeological collections; (v) drawings; (vi) paintings; (vii) sculptures; (viii) any work of art; or (ix) bullion;
(e) relative shall have the meaning assigned to it in the Explanation to clause (vi) of sub-section (2) of this section;
(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;

Section 56(2)(vii):
Memorandum explaining provisions
The Memorandum to Finance Bill, 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, particularly after abolition of the Gift Tax Act. The provisions were intended to extend the tax
net to such transactions in kind. The intent is not to tax the transactions entered into in the normal course of business or trade,
the profits of which are taxable under specific head of income. It is, therefore, 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, raw material and consumable stores of any business of such
recipient.
C. In several cases of immovable property transactions, there is a time gap between the booking of a property and the receipt
of such property on registration, which results in a taxable differential. It is, therefore, 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.
These amendments are proposed to take effect retrospectively from 1st October, 2009 and will, accordingly, apply in relation
to the assessment year 2010-11 and subsequent years.

Section 56(2)(vii): In Summary - Applicability &

Exclusions
Applicable to:
-

Money or moveable property or immovable property received by Individual / HUF; and

Value of above exceeds Rs.50,000.

Exclusions - Any gift received:

-

From any relative

On the occasion of the marriage of the individual

Under a will or by way of inheritance;

In contemplation of death of the payer;

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); or
From any trust or institution registered under section 12AA.

Section 56(2)(vii): Computation Mechanism

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

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Section 56(2)(vii) Issues

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Section 56(2)(vii): Issues

In case of immovable properties, the same amount would

become taxable in the hands of the transferor and the recipient
(i.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)?
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Section 56(2)(viia)
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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,
receives, in any previous year, from any person or persons, on or after the 1st day of June, 2010,
any property, being shares of a company not being a company in which the public are substantially
interested,
(i) without consideration, the aggregate fair market value of which exceeds fifty
thousand rupees, the whole of the aggregate fair market value of such property;
(ii) for a consideration which is less than the aggregate fair market value of the property
by an amount exceeding fifty thousand rupees, 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, fair market value of a property, being shares of a
company not being a company in which the public are substantially interested, shall have the
meaning assigned to it in the Explanation to clause (vii);
1

As inserted by Finance Act 2010

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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), 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. 50,000/-) by an individual or an HUF is chargeable to income tax in the hands of recipient under
the head income from other sources. However, 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. Therefore, transfer of shares of a company to a firm or a company, instead of an individual
or an HUF, without consideration or at a price lower than the fair market value does not attract the
anti-abuse provision.
In order to prevent the practice of transferring unlisted shares at prices much below their fair market
value, 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). Section 2(18) provides the definition
of a company in which the public are substantially interested.
It is also proposed to exclude the transactions undertaken for business reorganization,
amalgamation and demerger which are not regarded as transfer under clauses (via), (vic), (vicb),
(vid) and (vii) of section 47 of the Act.
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Section 56(2)(viia): Rationale

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

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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;

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;

A separate holding company (DHC) was formed at the helm of the group to take over the assets and
liabilities of the taxpayer. Further, an independent private equity concern infused funds into DHC for
exchange of DHCs shares.

Issues

AARs

Ruling

Whether any profit or gain within the meaning of Section 45 of the Act, 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 taxpayers 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;

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;

Relying on the ratio of the judgment in case of B. C. Srinivasa Setty, the AAR ruled that since in the present
case there was no consideration as prescribed in Section 48, there could be no capital gains chargeable to
tax under;

Section 92 of the Act is not a charging provision but a provision providing computational methodology;

If by application of Section 45 read with Section 48, the income could not be brought in the purview of tax
net in India, the TP provisions contained in Section 92 would not be applicable.
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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, European as well as Latin American companies. It was wholly owned by South Arabian Amiantit
Company.
The applicant holds 70% of the equity shares in an Indian operating company and also has a WOS in Cyprus
(an investment company), which held shares of various group entities.
As a part of group restructuring process, 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.

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, is required to withhold tax as per the provisions of section 195 of the Act?

AARs
On liability to tax in India
Ruling

When the computation provision cannot be applied, the charging provision fails. The Supreme Court in the
case of B.C. Srinivasa Setty had explained the scope of both the above provisions.
The income in the sense of profit and gain should be real but not hypothetical income. 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, the applicant was not liable to tax in India.
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.
On withholding tax
No liability to withhold tax under section 195 of the Act since income is not chargeable to tax.
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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 . 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, the value of which has been subject to incometax under clause (vii) and clause (viia) of sub-section (2)
of section 56, 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 FMV of the shares as per Section 56(2) to be
considered as cost of acquisition in the hands of recipient
of shares

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Section 56(2)(viia): Applicability

Shares in a
closely held
Indian / Foreign
co.

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.
(R / NR)

Recipient (a) Needs to be a Firm or a

Co. other than a Co. in which public are
substantially interested; (b) Can be a
R/NR
Transferor (a) Can be any Person;
(b) Can be a R/NR
Receipt of shares (a) Could be in
demat or physical form; (b) Could be
equity / preference shares; (c ) Shares
could be of an Indian / Foreign Co.
Receipt of shares Should be on or
after 1 June 2010;
Receipt of shares Shares should not
be in a Co. in which public are
substantially interested.

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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. from the

amalgamated Foreign Co. in a scheme of amalgamation

47(vic)

Receipt of shares in an Indian Co. by resulting Foreign Co. from the demerged
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 the shareholders of the demerged Co.
under a scheme of demerger

47(vii)

Receipt of shares in the amalgamated Co. by the shareholders of the

amalgamating Co. under a scheme of amalgamation

These exclusions are not applicable if shares received by an Individual and HUF
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Section 56(2)(viia): Computation Mechanism

Taxability under Section 56(2)(viia)
Situation 1: Where FMV of shares exceeds INR 50,000 and there is NIL consideration
Taxable Income: Aggregate FMV of the shares

Situation 2: Where there is inadequate consideration i.e. the consideration (say INR x) is less than
the aggregate FMV of the shares by an amount exceeding INR 50,000 Taxable income: Aggregate FMV of the shares exceeding the consideration (i.e. 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

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Section 56(2)(viia)- Issues

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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)?
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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, 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?
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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?

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Section 56(2)(viia): Issues

Threshold limit of INR 50,000 - Computation

For meeting the threshold limit of INR 50,000 whether receipt

of shares of each individual Co. should be considered or
should one aggregate shares of all companies received
during the year?

For determining the taxable amount, should one aggregate

transactions of inadequate / Nil consideration or, aggregate all
transactions including transactions with adequate consideration?

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Valuation Rules
28

Section 56(2)(vii) & (viia): Valuation Rules

Notification no. 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.

FMV will be:

Not transacted
through Stock
Exchange

i. the lowest price of such shares and securities on any recognized stock exchange
on the valuation date
ii. 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

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Section 56(2)(vii) & (viia): Valuation Rules

Notification no. 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.

PV = Paid up value of such equity shares.
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Section 56(2)(vii) & (viia): Valuation Rules

Notification no. 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. The taxpayer may obtain a report from a merchant banker or an accountant in respect
of such valuation.

Jewellery and Archaeological collection, Drawings, Paintings, 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.
In case the above property is received by any other mode and its value exceeds Rs.50,000, 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.

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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

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Thank You for

Your Interest and
Attention!!!

For any questions, please feel free to contact:

Prashant Kapoor, M&A - Tax Director
Direct: +91 124 334 5318
prashantkapoor@kpmg.com

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