Tax on Transfer of Unquoted Equity Shares(2 of 5) under Income Tax Act
The transfer of unquoted equity shares—those not listed on any recognized stock exchange—is common in internal restructuring, succession planning, stake sales, and startup exits. However, such transactions have significant tax implications under the Income Tax Act, 1961 for both the buyer and the seller.
For CAs, CFOs, CSs, Directors, and Founders, understanding capital gains provisions, valuation rules, exemptions, and compliance requirements is essential to avoid double taxation and litigation risk.
Income Tax Implications for Buyer and Seller
Unquoted shares lack market-determined prices, making them susceptible to under- or overvaluation. To address this, the Act applies two key anti-abuse provisions:
| Party | Applicable Section | Trigger | Taxability |
|---|---|---|---|
| Seller | Section 50CA | Sale price < FMV | FMV deemed as sale consideration for capital gains |
| Buyer | Section 56(2)(x) | Purchase price < FMV | FMV minus purchase price taxed as ‘Income from Other Sources’ |
Note: Both provisions may apply simultaneously, creating dual taxation.
Short-Term vs. Long-Term Capital Gains
The holding period determines whether gains are classified as STCG or LTCG:
Short-Term Capital Gains (STCG): Holding period ≤ 24 months – taxed at 15%
Long-Term Capital Gains (LTCG): Holding period > 24 months – taxed at 20%
Update: From 23rd July 2024, indexation is no longer allowed on LTCG for unquoted shares, though the 20% tax rate remains unchanged.
Key Components: Holding Period, Cost, Indexation, and Valuation
| Component | Explanation |
|---|---|
| Holding Period | From acquisition date to transfer date |
| Cost of Acquisition | Actual purchase price; or FMV in case of inheritance/gift |
| Indexation | Available only until 22nd July 2024 |
| Valuation Requirement | FMV must be computed as of transfer date, using Rule 11UA or merchant banker |
Valuation is mandatory when the transfer price is lower than FMV.
FMV Valuation – Rule 11UA Method
Under Rule 11UA(1)(c), the FMV of unquoted shares is determined using the Net Asset Value method or via valuation by a merchant banker or registered valuer.
FMV = (A + B + C + D – L) × (PV / PE)
Where:
A = Net tangible assets
B = Value of jewelry/artistic works
C = FMV of securities
D = Stamp duty value of immovable property
L = Book value of liabilities
PV = Paid-up value of shares being transferred
PE = Total paid-up equity capital
Exemptions and Special Scenarios
Tax Exemptions for Sellers
Section 54F: Reinvestment in one residential house (for individuals and HUFs)
Section 54EC: Investment in NHAI/REC bonds (limit: ₹50 lakh, within 6 months of sale)
Group Restructuring Exemptions – Section 47
Transactions like mergers, demergers, and holding-subsidiary transfers are exempt under specific conditions.
Gifts and Inheritance
Gift of shares is not taxable for the donor (Section 47).
In the hands of the recipient, tax applies only on subsequent sale, with the original holding period and cost carried over.
Tax Treatment Summary Table
| Transaction Scenario | Seller’s Tax Treatment | Buyer’s Tax Treatment |
|---|---|---|
| FMV > Sale Price | Capital gain on FMV (Sec 50CA) | FMV – Sale Price taxed (Sec 56(2)(x)) |
| FMV = Sale Price | Normal capital gains | No tax |
| Gift to Relative | Exempt (Sec 47) | Exempt if received from relative |
| Inherited Shares | Tax applies on sale only | Holding period continues |
| Sale after 24 months (LTCG) | 20% LTCG (no indexation post-23 Jul 2024) | — |
Frequently Asked Questions (FAQs)
1. How is FMV for unquoted shares determined?
As per Rule 11UA(1)(c), using the net asset value method or a valuation by a registered valuer or merchant banker.
2. Can I avoid dual taxation on undervalued transfers?
No. Both Section 50CA and Section 56(2)(x) apply, making proper FMV-based valuation essential.
3. Are share gifts taxable?
Gifts to relatives or via will/inheritance are exempt. Others may be taxed under Section 56(2)(x) if FMV > ₹50,000.
4. Is indexation allowed on LTCG for unquoted shares?
No, indexation benefit is not allowed after 23rd July 2024.
5. Are group transfers exempt from tax?
Yes, if conditions under Section 47 are satisfied (e.g., holding-subsidiary transfers, mergers, demergers).
How Nexpective Advisors Can Assist
We offer expert guidance across all aspects of unquoted share transfer transactions:
Capital Gains Computation for Buyers & Sellers
FMV Valuation under Rule 11UA
Registered Valuer Certification
Tax Advisory for Group Restructuring
Inheritance and Gift Tax Planning
Transaction Documentation and Audit Trail Support
Contact us today to ensure your transaction is compliant, tax-efficient, and audit-ready.
Conclusion
Transfers of unquoted equity shares come with significant tax risks and complex valuation requirements. With dual taxation implications and strict valuation norms, missteps can lead to penalties or litigation.
By aligning transactions with FMV-based rules, leveraging exemptions, and engaging valuation and tax professionals, stakeholders can navigate these transactions with confidence and compliance.
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