Determination of fair market value of unquoted equity shares of Start Up companies u/s 56(2)(viib)-CBDT Instruction

Determination of fair market value of unquoted equity shares of ‘Start Up’ companies under section 56(2)(viib) of the Income-tax Act read with Rule 11UA(2) of Income-tax Rules-CBDT Instruction

Section 56(2)(viib) of the Income-tax Act, 1961 (Act) provides that where a closely held company issues its shares at a price which is more than its fair market value, the amount received in excess of fair market value will be charged to tax in the hands of the company as income from other sources.

Explanation to section 56(2)(viib) of the Act prescribes various methods for valuation of fair market value of shares of the closely held company. Among the various options for valuation of fair market value, one of the methods prescribed is based on fair market value of the unquoted equity shares as determined by a merchant banker or an accountant as per the Discounted Free Cash Flow Method.

Central Board of Direct Taxes (CBDT) has issued an instruction to all the Pr CITs on the issue of Assessing Officers invoking section 56(2)(viib) in case of ‘Start Up’ companies which has otherwise raised a genuine investment on the basis of their ‘idea’.

According to the CBDT, as per the information received, during the assessments, ‘Start Up’ companies submit a valuation report from a merchant banker or an accountant based on Discounted Free Cash Flow Method as prescribed in Rule 11UA(2)(b) of Income-tax Rules, However, in such reports are not being accepted and rejected/modified by the Assessing Officers by treating them as based upon abnormal valuations resulting in additions being made u/s 56(2)(viib) of the Act in cases of ‘Start Up’ companies.

CBDT has instructed that in case of ‘Start Up’ companies which fall within the definition given in Notification of DIPP, of Commerce & Industry, in G.S.R. SOl(E) dated 23.05.2017, if additions have been made by the Assessing Officer under section 56(2)(viib) of the Act after modifying/rejecting the valuation so furnished under Rule 11UA(2), no coercive measure to recover the outstanding demand would be taken.

Further, it has been also instructed that all such cases, pending with the Commissioner (Appeals), necessary administrative steps should be taken for expeditious disposal of appeals, preferably by 31st March, 2018.

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