The Central Board of Direct Taxes has amended rules 11U and 11UA of the Income-tax Rules, 1962. The provisions of Section 56(2)(vii)/ (viia) of the Income-tax Act deals with taxing in the hands of the recipient the difference between the undervalued consideration and the fair market value of specified properties; Section 56(2)(viib) deals with taxing in the hands of the company the consideration for issue of shares to a resident that exceeds the fair market value. Rule 11UA has been amended to provide for specific valuation principles applicable to unquoted shares under Section 56(2)(viib) of the Act. This amendment includes the Discounted Free Cash Flow (DCF) method for determining the fair market value of such shares.
Previously, for section 56 the method prescribed for calculating the fair market value of the shares was based on the book value of the assets (NAV method), which may not correctly correspond to the fair value, or the value as substantiated to the satisfaction of the assessing officer. As the DCF method represents the net current value of the projected cash flows, it is a more sound valuation. However, the question is whether such benefit of the DCF valuation is available to the taxpayer company for transactions executed between April 1 and November 29, 2012.
The notification has also amended the definition of “balance sheet” in relation to section 56(2)(vii)/ (viia) of the Act. For a share purchase transaction between two shareholders of a private company covered under section 56(2)(viia), the balance sheet for calculating NAV is on the date of receipt of consideration, duly audited by the statutory auditor (previously, it was NAV based on the balance sheet last audited), thereby taking care of practical issues such as how the shareholder can get the company to have the financials audited, more so when in minority.
Recently the Mumbai Income Tax Appellate Tribunal, in the case of WNS North America Inc vs. ADIT, held that retrospective amendment to the Income-tax Act shall not affect the provisions of Double Taxation Avoidance Agreement (DTAA).
WNS Global Services Pvt Ltd reimbursed international telecom connectivity charges to the assessee, which was treated by the tax officer as royalty under Article 12 of the India-US DTAA. Based on an earlier favourable tribunal order in its own case, the assessee contended that the payment is not royalty. The tax department cited a retrospective insertion in Section 9(1)(vi) through Finance Act, 2012.
The court held that retrospective amendment shall alter the provisions of the I-T Act, but will not per se automatically alter the analogous provision of the treaty due to Section 90(2), which provides that the assessee has more beneficial provision from the I-T Act and DTAA. The court also held that the retrospective amendment will apply only in the absence of any contrary provisions in DTAA.
Intangibles still a vexed issue
Claim of depreciation on payment for transfer of business along with contracts, clients and client relationship as ‘intangible assets’ has always been controversial.
Recently, the Mumbai Income-Tax Appellate Tribunal, in the case of India Capital Markets Pvt Ltd, held that the purchase of the clientele business of a sub-broker is a right which can be used as a tool to carry on the business. Further, the consideration paid for acquiring the clientele is an ‘intangible asset’ and eligible for depreciation under Section 32(1)(ii) of the Income-Tax Act, 1961. The tribunal observed that the specific words of Section 32 reveal the similarity — in the sense that all the ‘intangible assets’ specified are tools of the trade that facilitate the taxpayer to carry on the business. Therefore, the expression ‘any other business or commercial rights of similar nature’ would include such rights that can be used as tools to carry on the business.
The tribunal referred the decision in the case of Weizman Forex Ltd, where it was observed that the definition of the asset includes all contracts, licences, franchise, distribution network, customer lists, marketing strategies and software. Further, if the asset is used as a business tool for earning income, physical wear and tear or diminishing of value of the intangible asset is not an essential condition for admissibility of depreciation.
However, the Mumbai tribunal in the case of Ind Global Corporate Finance Pvt Ltd held that payment for transfer of business along with contracts, clients and client relationship would not be eligible for depreciation, as there was no material produced by the taxpayer to show that any part of the payment was related to any knowhow that can be considered an ‘intangible asset’, as mentioned under Section 32(1)(ii) of the I-T Act.