Capital gains from unlisted shares: Govt may use net asset value method to calculate FMV

The tax department is likely to calculate the fair market value (FMV) of unlisted shares by the net asset value method for computing capital gains tax arising out of the transfer of such shares.

The government has proposed in the budget that the tax department would compute capital gains from transfer of unlisted shares at less at the selling price or fair market value (FMV), whichever is higher, and that it would come out with the method for calculation of fair market value.

According to some tax experts, tax and revenue officials have hinted that the main objective of inserting this section in the Income Tax Act is to target sale of properties at undervalued prices though the company structure, and that they would use the net asset value to calculate FMV instead of the discounted cash flow (DCF) method.

The net asset value is expected to reflect the fair market value of the property. If the fair market value is calculated by the DCF method that would have led to many litigations because DCF method of calculation is very subjective, thus giving discretionary power in the hands of tax officials, who may contest the fair market value of the shares calculated by a company for sale of shares.

As per the budget announcement, "If the consideration received a result of the transfer by shares of an unlisted company is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined should, for the purpose of computation of capital gains, be deemed to be the full value of consideration received or accruing as a result of such transfer."

This announcement came as a major dampener for unlisted companies especially the start-ups where a lot of deals takes place and promoters, private equity investors and venture capital funds keep selling their stakes.