Sec 56
This query is : Resolved
04 February 2014
Are provisions of Sec 56(2)(viia) or 56(2)(viib) applicable on preference shares also or is it meant for equity shares only? Please suggest, its urgent.
04 February 2014
It is applicable on all shares which has market value. In case of preference shares there are conditions and these cannot be traded in the market. If there is % fixed on preference shares then they will get preference in getting divided and at the time liquidation also they will get preference therefore, in my opinion these are not covered u/s 56. However kindly note the following:
The Finance Act,2012 inserted clause
(viib) in section56(2) of the Income-tax
Act,1961 (“Act”) with effect from April
1,2012 to bring within the purview of taxation the premium received by a company (other than a “company in which public
are substantially interested”
[1], on the issue of its shares in excess of the “Fair Market Value” (‘FMV’) of such shares. The FMV was to be the price (a) Arrived at as per the prescribed method OR (b) as may be substantiated to the assessing officer based on the value of the company at the time of issue of the shares. Also, as per the existing clause
(viia) of section 56(2), if the consideration paid for the acquisition of shares (of a closely held company) is lower than the FMV of the shares,
the delta is treated as income of the company or firm that acquires such shares.
Rule 11U and Rule 11UA of the Income - tax Rules, 1962 (‘IT Rules’), amongst other
things, prescribed the Net Asset Value Method (based on Balance Sheet values) for
arriving at the FMV for the purposes of this clause (viia).
No valuation rule was however prescribed for the purposes of clause (viib) of
section 56(2).
The CBDT has now issued a Notification
amending Rules 11U and 11UA of the IT
Rules to provide for a valuation method for the purposes of clause (viib) of
section 56(2) and also to make other incidental changes
.
Key amendments to the valuation rules
Valuation method for clause (viib) of section 56(2)
–
Rule 11UA has been amended to allow the company issuing shares to determine the FMV either based on the (a) book value as per the Balance Sheet OR (b) based on the Discounted Free Cash Flow method. Valuer
–
Rule 11UA has been amended to provide that the valuation for the purposes of clause (viib) has to be certified either by (a) a Fellow member of the Institute of Chartered Accountants of India (FCA) OR (b) by a merchant banker. Also, the FCA certifying the valuation should not be a tax auditor or statutory auditor of the company.
The Finance Act,2012 inserted clause
(viib) in section56(2) of the Income-tax
Act,1961 (“Act”) with effect from April
1,2012 to bring within the purview of taxation the premium received by a company (other than a “company in which public
are substantially interested”
[1], on the issue of its shares in excess of the “Fair Market Value” (‘FMV’) of such shares. The FMV was to be the price (a) Arrived at as per the prescribed method OR (b) as may be substantiated to the assessing officer based on the value of the company at the time of issue of the shares. Also, as per the existing clause
(viia) of section 56(2), if the consideration paid for the acquisition of shares (of a closely held company) is lower than the FMV of the shares,
the delta is treated as income of the company or firm that acquires such shares.
Rule 11U and Rule 11UA of the Income - tax Rules, 1962 (‘IT Rules’), amongst other
things, prescribed the Net Asset Value Method (based on Balance Sheet values) for
arriving at the FMV for the purposes of this clause (viia).
No valuation rule was however prescribed for the purposes of clause (viib) of
section 56(2).
The CBDT has now issued a Notification
amending Rules 11U and 11UA of the IT
Rules to provide for a valuation method for the purposes of clause (viib) of
section 56(2) and also to make other incidental changes
.
Key amendments to the valuation rules
Valuation method for clause (viib) of section 56(2)
–
Rule 11UA has been amended to allow the company issuing shares to determine the FMV either based on the (a) book value as per the Balance Sheet OR (b) based on the Discounted Free Cash Flow method. Valuer
–
Rule 11UA has been amended to provide that the valuation for the purposes of clause (viib) has to be certified either by (a) a Fellow member of the Institute of Chartered Accountants of India (FCA) OR (b) by a merchant banker. Also, the FCA certifying the valuation should not be a tax auditor or statutory auditor of the company.
04 February 2014
Thanks Sir. The method for calculating FMV is also given for equity shares only. Would there be any tax implication, if in future preference shares get converted into equity shares?
23 July 2025
Great question! Let’s break down the provisions of Section 56(2)(viia) and Section 56(2)(viib), and their application specifically to preference shares versus equity shares, as well as the implications of conversion of preference shares into equity shares.
1. Are the provisions of Section 56(2)(viia) and 56(2)(viib) applicable to preference shares or only to equity shares?
Section 56(2)(viia):
This section deals with the transfer of unquoted equity shares (either as gifts or at below market value). The section specifies that the fair market value (FMV) of unquoted equity shares is to be taken into account when the shares are transferred without consideration or at less than their FMV. The relevant valuation method is mentioned for equity shares only, and the provisions apply to equity shares specifically.
Section 56(2)(viib):
This section specifically deals with the issue of unquoted equity shares by a company. It mandates that the FMV of shares issued to non-resident investors or to a person other than a resident, should be calculated and the consideration received should not exceed the FMV. The valuation is again specifically meant for equity shares.
Application to Preference Shares:
The provisions of Section 56(2)(viia) and 56(2)(viib) do not directly apply to preference shares because these provisions refer explicitly to equity shares. The FMV calculation and the treatment outlined are for equity shares issued or transferred at below FMV or at a discount.
2. Method for Calculating FMV:
The method for calculating FMV is given specifically for equity shares, and there is no direct mention of preference shares in this context.
Preference shares may have a fixed dividend and no voting rights, which differentiates them from equity shares. Therefore, their valuation would generally be done based on different parameters—such as fixed dividends, redemption rights, or other terms specific to the preference shares.
FMV for Preference Shares:
While FMV for preference shares is not detailed in the same manner as for equity shares under Section 56, preference shares can still be valued based on their own specific features, such as:
Dividend yield
Preference in liquidation
Conversion rights (if any)
Redemption terms
A merchant banker or chartered accountant can assist in determining the FMV of preference shares for tax and compliance purposes.
3. Tax Implications of Conversion of Preference Shares into Equity Shares:
If preference shares are converted into equity shares, there could be tax implications, particularly in the following areas:
Conversion as a Transfer:
In the eyes of the Income Tax Act, conversion of preference shares into equity shares can sometimes be treated as a transfer (depending on the specific terms of conversion). If the preference shares are converted into equity shares, and if there is a difference between the issue price of the preference shares and the FMV at the time of conversion, it could trigger a tax liability under Section 56(2)(viib) (if the preference shares are treated as a transfer of equity shares).
Section 56(2)(viib) Implication: If preference shares are converted into equity shares, and if the FMV of the equity shares at the time of conversion exceeds the consideration paid for the preference shares, then the company might have to account for the difference under Section 56(2)(viib) as income.
The conversion of preference shares into equity shares could be viewed as an indirect issue of equity shares for tax purposes, and the company may be required to determine the FMV of those equity shares at the time of conversion. This could result in a potential taxable event for the company or for the shareholder, depending on the terms of conversion.
Capital Gains: If the conversion is treated as a transfer, the preference shareholder may be liable to pay capital gains tax on the conversion, depending on the holding period and other conditions.
Practical Example:
Let’s say a company issues preference shares at ₹100, and later those shares are converted into equity shares. If the FMV of the equity shares at the time of conversion is ₹150, the difference of ₹50 could be treated as income under Section 56(2)(viib), as it is considered the price at which equity shares are being issued.
The company will need to account for the FMV of equity shares and ensure proper reporting under relevant tax provisions. If the preference shares were issued at below the FMV of equity shares at the time of conversion, the company may need to recognize the difference as income.
Conclusion:
Section 56(2)(viia) and 56(2)(viib) provisions specifically apply to equity shares and not to preference shares. Preference shares are treated separately and are subject to different valuation methods.
FMV Calculation for Preference Shares: Although FMV calculation methods for preference shares are not detailed under these sections, preference shares can still be valued based on their features (e.g., fixed dividends, redemption rights). It’s advisable to consult a merchant banker or CA to determine the FMV.
Conversion of Preference Shares to Equity Shares:
If preference shares are converted into equity shares, this could potentially trigger tax implications, depending on the FMV of the equity shares at the time of conversion and how the conversion is structured.
There could be a taxable event under Section 56(2)(viib) if the FMV of the converted equity shares exceeds the price at which preference shares were originally issued.
1. Are the provisions of Section 56(2)(viia) and 56(2)(viib) applicable to preference shares or only to equity shares?
Section 56(2)(viia):
This section deals with the transfer of unquoted equity shares (either as gifts or at below market value). The section specifies that the fair market value (FMV) of unquoted equity shares is to be taken into account when the shares are transferred without consideration or at less than their FMV. The relevant valuation method is mentioned for equity shares only, and the provisions apply to equity shares specifically.
Section 56(2)(viib):
This section specifically deals with the issue of unquoted equity shares by a company. It mandates that the FMV of shares issued to non-resident investors or to a person other than a resident, should be calculated and the consideration received should not exceed the FMV. The valuation is again specifically meant for equity shares.
Application to Preference Shares:
The provisions of Section 56(2)(viia) and 56(2)(viib) do not directly apply to preference shares because these provisions refer explicitly to equity shares. The FMV calculation and the treatment outlined are for equity shares issued or transferred at below FMV or at a discount.
2. Method for Calculating FMV:
The method for calculating FMV is given specifically for equity shares, and there is no direct mention of preference shares in this context.
Preference shares may have a fixed dividend and no voting rights, which differentiates them from equity shares. Therefore, their valuation would generally be done based on different parameters—such as fixed dividends, redemption rights, or other terms specific to the preference shares.
FMV for Preference Shares:
While FMV for preference shares is not detailed in the same manner as for equity shares under Section 56, preference shares can still be valued based on their own specific features, such as:
Dividend yield
Preference in liquidation
Conversion rights (if any)
Redemption terms
A merchant banker or chartered accountant can assist in determining the FMV of preference shares for tax and compliance purposes.
3. Tax Implications of Conversion of Preference Shares into Equity Shares:
If preference shares are converted into equity shares, there could be tax implications, particularly in the following areas:
Conversion as a Transfer:
In the eyes of the Income Tax Act, conversion of preference shares into equity shares can sometimes be treated as a transfer (depending on the specific terms of conversion). If the preference shares are converted into equity shares, and if there is a difference between the issue price of the preference shares and the FMV at the time of conversion, it could trigger a tax liability under Section 56(2)(viib) (if the preference shares are treated as a transfer of equity shares).
Section 56(2)(viib) Implication: If preference shares are converted into equity shares, and if the FMV of the equity shares at the time of conversion exceeds the consideration paid for the preference shares, then the company might have to account for the difference under Section 56(2)(viib) as income.
The conversion of preference shares into equity shares could be viewed as an indirect issue of equity shares for tax purposes, and the company may be required to determine the FMV of those equity shares at the time of conversion. This could result in a potential taxable event for the company or for the shareholder, depending on the terms of conversion.
Capital Gains: If the conversion is treated as a transfer, the preference shareholder may be liable to pay capital gains tax on the conversion, depending on the holding period and other conditions.
Practical Example:
Let’s say a company issues preference shares at ₹100, and later those shares are converted into equity shares. If the FMV of the equity shares at the time of conversion is ₹150, the difference of ₹50 could be treated as income under Section 56(2)(viib), as it is considered the price at which equity shares are being issued.
The company will need to account for the FMV of equity shares and ensure proper reporting under relevant tax provisions. If the preference shares were issued at below the FMV of equity shares at the time of conversion, the company may need to recognize the difference as income.
Conclusion:
Section 56(2)(viia) and 56(2)(viib) provisions specifically apply to equity shares and not to preference shares. Preference shares are treated separately and are subject to different valuation methods.
FMV Calculation for Preference Shares: Although FMV calculation methods for preference shares are not detailed under these sections, preference shares can still be valued based on their features (e.g., fixed dividends, redemption rights). It’s advisable to consult a merchant banker or CA to determine the FMV.
Conversion of Preference Shares to Equity Shares:
If preference shares are converted into equity shares, this could potentially trigger tax implications, depending on the FMV of the equity shares at the time of conversion and how the conversion is structured.
There could be a taxable event under Section 56(2)(viib) if the FMV of the converted equity shares exceeds the price at which preference shares were originally issued.
You need to be the querist or approved CAclub expert to take part in this query .
Click here to login now
Click here to login now
Similar Resolved Queries
Unanswered Queries
- Required to submit form 10IEA_fy 24-25
- Error whilst validation
- ITR2 Not Validating Short Term Capital Loss as value less than zero
- ITR3
- Rebate u/sec. 87A manually
- ERRROR IN ITR2 FILING
- GSTR ITC relationship
- Ewaybill Material value reg
- NRE account -account type issue in AY2025-26 Tax Filing
- Form 15G eligibility for individuals
- PT interest calculation
- ICWAI-Final
- List of Platform for crypto trading
- Gratuity Fund Audit & ITR
- RCM gst liability and return query
- Hash value error indicated whilst validating itr 2 online
- Allowability of itc on building materials etc for resorts
- HSN details in Table 12 for gstr1
- Profit transfer entry from one branch to head office branch
- RCM on affiliation fees paid to foreign educational institution
Trending Online Classes
CAclubindia
