Supreme Court clarifies valuation of locked-in shares under Gift Tax Act: Deputy Commissioner of Gift Tax vs. BPL Limited (2022)

Date of the Judgment: 13 October 2022

Citation: Civil Appeal No. 3265 of 2016

Judges: Sanjiv Khanna, J. and J.K. Maheshwari, J.

Can shares that cannot be freely traded due to a lock-in period be valued at their market price or should a different method be used for gift tax purposes? The Supreme Court of India addressed this question in a case concerning the valuation of shares gifted by M/s BPL Limited. The court clarified that shares under a lock-in period are not considered “quoted shares” and must be valued using a specific method outlined in the Wealth Tax Act, 1957. This judgment provides important guidance on how to assess the value of such restricted shares for tax purposes. The bench comprised of Justice Sanjiv Khanna and Justice J.K. Maheshwari.

Case Background

M/s BPL Limited gifted 29,46,500 shares of M/s. BPL Sanyo Technologies Limited and 69,49,900 shares of M/s. BPL Sanyo Utilities and Appliances Limited to M/s. Celestial Finance Limited on 2nd March 1993. These shares were originally allotted to M/s BPL Limited as promoter quota shares on 17th November 1990 and 10th July 1991, respectively. However, these shares were subject to a lock-in period, restricting their transfer until 16th November 1993 and 25th May 1994, respectively.

Timeline:

Legal Framework

The Gift Tax Act, 1958 (G.T. Act) stipulates that gift tax is applicable on the market value of a gift exceeding the consideration, as per Section 4(1)(a) of the G.T. Act. Section 6(1) of the G.T. Act states that the value of a gift is determined on the date of the gift, as per Schedule II of the G.T. Act. Schedule II of the G.T. Act mandates that valuation must be done as per Schedule III of the Wealth Tax Act, 1957 (W.T. Act). Specifically, Part C of Schedule III of the W.T. Act is relevant, which deals with valuation of shares and debentures. Rule 9 of Part C of Schedule III of the W.T. Act pertains to valuation of quoted shares, while Rule 11 deals with unquoted shares. The definitions of “quoted” and “unquoted” shares are provided in Rule 2(9) and 2(11) of Part A of Schedule III of the W.T. Act.

Section 4(1)(a) of the Gift Tax Act, 1958:
“where property is transferred otherwise than for adequate consideration, the amount by which the market value of the property at the date of the transfer exceeds the value of the consideration shall be deemed to be a gift made by the transferor”

Section 6(1) of the Gift Tax Act, 1958:
“Subject to the provisions of sub-section (2), the value of any property, other than cash, transferred by way of gift shall for the purpose of this Act, be its value as on the date on which the gift was made and shall be determined in the manner laid down in Schedule II.”

Rule 9 of Part C of Schedule III of the Wealth Tax Act, 1957:
“The value of an equity share or a preference share in any company or a debenture of any company which is a quoted share or a quoted debenture shall be taken as the value quoted in respect of such share or debenture on the valuation date or where there is no such quotation on the valuation date, the quotation on the date closest to the valuation date and immediately preceding such date.”

Rule 11 of Part C of Schedule III of the Wealth Tax Act, 1957:
“(1) The value of an unquoted equity share in any company, other than an investment company, shall be determined in the manner set out in sub-rule (2).
(2) The value of all the liabilities as shown in the balance-sheet of such company shall be deducted from the value of all its assets shown in that balance-sheet; the net amount so arrived at shall be divided by the total amount of its paid-up equity share capital as shown in the balance sheet; the result multiplied by the paid-up value of each equity share shall be the break-up value of each unquoted equity share, and an amount equal to eighty per cent of the break-up value so determined shall be the value of the unquoted equity share for the purposes of this Act.”

Rule 2(9) of Part A of Schedule III of the Wealth Tax Act, 1957:
““quoted share” or “quoted debenture”, in relation to an equity share or a preference share or, as the case may be, a debenture, means a share or debenture quoted on any recognised stock exchange with regularity from time to time, where the quotations of such shares or debentures are based on current transactions made in the ordinary course of business.”

Rule 2(11) of Part A of Schedule III of the Wealth Tax Act, 1957:
““unquoted share” or “unquoted debenture”, in relation to an equity share or a preference share or, as the case may be, a debenture, means a share or debenture which is not a quoted share or a quoted debenture.””

Arguments

Arguments by the Deputy Commissioner of Gift Tax:

• The Revenue contended that the shares, though under a lock-in period, could be transferred between promoters and thus should be valued as quoted shares based on market price.
• The Revenue relied on a SEBI circular stating that shares under lock-in can be transferred inter se promoters.
• The Revenue argued that Rule 21 of Part H of Schedule III of the W.T. Act states that restrictive covenants should be ignored while determining market value.

Arguments by M/s BPL Limited:

• M/s BPL Limited argued that shares under lock-in cannot be considered “quoted shares” because they are not traded regularly on stock exchanges.
• They contended that since the shares are not freely transferable, they should be valued as “unquoted shares” as per Rule 11 of Part C of Schedule III of the W.T. Act.
• They argued that the lock-in period significantly impacts the value of the shares and should be considered during valuation.

Analysis of Arguments:

The Deputy Commissioner of Gift Tax argued for a market-based valuation, emphasizing the possibility of transfer between promoters and citing Rule 21 to ignore restrictions. M/s BPL Limited, on the other hand, focused on the lack of regular trading and the impact of the lock-in period, advocating for valuation as unquoted shares under Rule 11. The core disagreement lies in whether the restricted transferability of lock-in shares allows them to be considered “quoted shares” for valuation purposes.

Innovativeness of the argument: The argument by M/s BPL Limited was innovative as it focused on the practical implications of the lock-in period on the shares’ marketability and value, rather than just relying on the literal definition of “quoted shares”.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue:

1. Whether the equity shares under a lock-in period should be considered as “quoted shares” or “unquoted shares” for the purpose of valuation under the Gift Tax Act, 1958?

Treatment of the Issue by the Court

Authorities

Cases Referred to by the Court:

• Ahmed G.H. Ariff and Others v. Commissioner of Wealth Tax, Calcutta, (1969) 2 SCC 471: The Supreme Court held that the term ‘property’ has a wide connotation and that restrictions on transfer do not mean the property has no value.
• Purshottam N. Amarsay and Another v. Commissioner of Wealth Tax, Bombay, (1972) 4 SCC 376: The Supreme Court reiterated that restrictions on transfer do not make a property valueless.
• Commissioners of Inland Revenue v. Crossman, (1937) A.C. 26: The House of Lords held that shares with transfer restrictions should be valued by considering those restrictions.
• Lynall and Another v. Inland Revenue Commissioners, (1972) A.C. 680: The House of Lords reiterated the principles laid down in Crossman’s case.
• Abrahams v. The Federal Commissioner of Taxation, (1944) HCA 32: The High Court of Australia held that restrictions on share transfers should be considered when valuing shares.
• R. Rathinasabapathy Chettiar v. Commissioner of Wealth-Tax, Madras, (1974) 93 ITR 555: The Madras High Court held that restrictions on share transfers should be considered when valuing shares.
• Commissioner of Wealth Tax, Chennai v. Shri Thirupathy Kumar Khemka, (2012) SCC OnLine Mad 2562: The Madras High Court followed the principles laid down in R. Rathinasabapathy Chettiar.
• Commissioner of Income Tax, Chennai v. Sadhana Devi, Tax Case No. 788 of 2008: The Madras High Court considered the valuation of shares in lock-in period as per the provisions of Schedule III of the W.T. Act.
• S.N. Wadiyar (Dead) through Legal Representative v. Commissioner of Wealth Tax, Karnataka, (2015) 15 SCC 38: The Supreme Court emphasized that the method of valuation stipulated under the rules or the Schedule is mandatory.
• Commissioner of Wealth Tax, Meerut v. Sharvan Kumar Swarup & Sons, (1994) 6 SCC 623: The Supreme Court held that the machinery provision relating to the method of valuation in Schedule II of the G.T. Act is mandatory and cannot be deviated.

Legal Provisions Considered by the Court:

• Section 4(1)(a) of the Gift Tax Act, 1958: Defines what constitutes a gift for tax purposes.
• Section 6(1) of the Gift Tax Act, 1958: Specifies how the value of a gift is determined.
• Schedule II of the Gift Tax Act, 1958: Mandates the use of Schedule III of the Wealth Tax Act, 1957 for valuation.
• Rule 9 of Part C of Schedule III of the Wealth Tax Act, 1957: Pertains to the valuation of quoted shares.
• Rule 11 of Part C of Schedule III of the Wealth Tax Act, 1957: Pertains to the valuation of unquoted shares.
• Rule 2(9) of Part A of Schedule III of the Wealth Tax Act, 1957: Defines “quoted share”.
• Rule 2(11) of Part A of Schedule III of the Wealth Tax Act, 1957: Defines “unquoted share”.
• Rule 21 of Part H of Schedule III of the Wealth Tax Act, 1957: States that restrictive covenants should be ignored in determining market value.

Judgment

How each authority was viewed by the Court?

• The Court relied on Ahmed G.H. Ariff and Others v. Commissioner of Wealth Tax, Calcutta, (1969) 2 SCC 471* to emphasize that the term ‘property’ has a wide connotation and that restrictions on transfer do not mean the property has no value.
• The Court followed Purshottam N. Amarsay and Another v. Commissioner of Wealth Tax, Bombay, (1972) 4 SCC 376* to reiterate that restrictions on transfer do not make a property valueless.
• The Court took guidance from Commissioners of Inland Revenue v. Crossman, (1937) A.C. 26* to hold that shares with transfer restrictions should be valued by considering those restrictions.
• The Court followed Lynall and Another v. Inland Revenue Commissioners, (1972) A.C. 680* to reiterate the principles laid down in Crossman’s case.
• The Court relied on Abrahams v. The Federal Commissioner of Taxation, (1944) HCA 32* to hold that restrictions on share transfers should be considered when valuing shares.
• The Court took guidance from R. Rathinasabapathy Chettiar v. Commissioner of Wealth-Tax, Madras, (1974) 93 ITR 555* to hold that restrictions on share transfers should be considered when valuing shares.
• The Court followed Commissioner of Wealth Tax, Chennai v. Shri Thirupathy Kumar Khemka, (2012) SCC OnLine Mad 2562* where the Madras High Court followed the principles laid down in R. Rathinasabapathy Chettiar.
• The Court followed Commissioner of Income Tax, Chennai v. Sadhana Devi, Tax Case No. 788 of 2008* where the Madras High Court considered the valuation of shares in lock-in period as per the provisions of Schedule III of the W.T. Act.
• The Court followed S.N. Wadiyar (Dead) through Legal Representative v. Commissioner of Wealth Tax, Karnataka, (2015) 15 SCC 38* to emphasize that the method of valuation stipulated under the rules or the Schedule is mandatory.
• The Court followed Commissioner of Wealth Tax, Meerut v. Sharvan Kumar Swarup & Sons, (1994) 6 SCC 623* to hold that the machinery provision relating to the method of valuation in Schedule II of the G.T. Act is mandatory and cannot be deviated.

The Supreme Court held that the shares under a lock-in period are not “quoted shares” as defined in the Wealth Tax Act, 1957. The court stated that these shares are not traded regularly on stock exchanges and, therefore, do not meet the criteria for being considered “quoted shares.” The court emphasized that the valuation of such shares must be done according to Rule 11 of Part C of Schedule III of the W.T. Act, which pertains to “unquoted shares.” The Court clarified that Rule 21 of Part H of Schedule III of the W.T. Act does not allow for ignoring the restrictions on transfer, but rather mandates that the valuation should consider these restrictions. The court rejected the Revenue’s argument that the possibility of transfer between promoters makes the shares “quoted shares.”

“These equity shares being under the lock-in period could not be traded and, therefore, remained unquoted in any recognised stock exchange. There, therefore, would be no current transactions in respect of these shares made in the ordinary course of business.”

“The shares in question being “unquoted shares”, therefore, have to be valued in terms of Rule 11 as a standalone valuation method.”

“Rule 21 of Part H of Schedule III of the W.T. Act permits valuation of the property even when the right to transfer the property is forbidden, restricted or contingent.”

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Statutory Interpretation: The Court strictly interpreted the definitions of “quoted” and “unquoted” shares as provided in the Wealth Tax Act, 1957.
• Marketability: The lack of regular trading of locked-in shares on stock exchanges was a key factor in determining that they are not “quoted shares.”
• Restrictions on Transfer: The Court recognized that the lock-in period significantly impacts the marketability and value of the shares.
• Rejection of Hybrid Valuation: The Court rejected any hybrid method of valuation, emphasizing that the valuation must be done as per the prescribed rules.
• Clarification of Rule 21: The Court clarified that Rule 21 does not mean disregarding restrictions but rather considering them while valuing the shares.

Fact:Law Ratio:

Logical Reasoning:

Key Takeaways

• Shares under a lock-in period are considered “unquoted shares” for gift tax purposes.
• The valuation of such shares must be done as per Rule 11 of Part C of Schedule III of the Wealth Tax Act, 1957.
• Rule 21 of Part H of Schedule III of the W.T. Act does not allow for ignoring restrictions on transfer, but rather mandates that the valuation should consider these restrictions.
• The possibility of transfer between promoters does not make the shares “quoted shares.”
• This judgment provides clarity on how to value restricted shares for tax purposes, ensuring consistency and fairness.

Directions

No specific directions were given by the Supreme Court in this case.

Specific Amendments Analysis

There were no specific amendments discussed in the judgment.

Development of Law

The ratio decidendi of this case is that shares under a lock-in period are considered “unquoted shares” and must be valued as per Rule 11 of Part C of Schedule III of the Wealth Tax Act, 1957. This judgment clarifies the valuation method for such shares, ensuring that their restricted transferability is taken into account. There is no change in the previous position of law, but it clarifies the existing position.

Conclusion

The Supreme Court’s judgment in the case of Deputy Commissioner of Gift Tax vs. M/s BPL Limited clarifies that shares under a lock-in period are not “quoted shares” and must be valued as “unquoted shares” under Rule 11 of Part C of Schedule III of the Wealth Tax Act, 1957. This decision provides important guidance on the valuation of restricted shares for gift tax purposes, emphasizing the need to consider the restrictions on transferability when determining their market value.