Circular No. 118

What this is

Circular No. 118 was issued by the Central Board of Direct Taxes on 15 September 1973. Its subject is Valuation of unquoted equity shares of investment companies, holding companies, etc. - Guidelines therefor.

This is a clarification. The Board is stating how it reads a provision. That reading binds the department; it does not bind a court, and where the section says otherwise the section wins.

What it does

Modifies in part Circular No. 2 (WT) of 1967 dated 31 October 1967 for valuing unquoted equity shares of an investment company that has one or more wholly-owned subsidiaries. The asset backing must be computed treating the whole enterprise, parent and wholly-owned subsidiaries, as a single company, taking the subsidiaries' reserves into account. In practice the value of a share of the parent is first found on that consolidated basis, by assimilating the subsidiaries' balance sheets with the parent's and correctly adjusting inter-company balances. Second, the maintainable profits of the parent and each wholly-owned subsidiary are determined separately in the manner laid down in the 1967 circular and then aggregated, and the capitalised value is found by applying a rate of yield of 9 per cent to the aggregate. The average of the two figures is the price the share would fetch in the open market on the valuation date. Paragraph 3 of the 1967 circular does not apply to a parent investment company with a wholly-owned subsidiary. The instructions are to be followed with immediate effect in all matters, including pending proceedings.

Why it was issued

The Board issued directions for the particular case of an investment company holding wholly-owned subsidiaries, which the general 1967 guidance did not deal with adequately.

Who it reaches

• Shareholders of investment companies holding wholly-owned subsidiaries
• Valuers consolidating group balance sheets for this purpose
• Wealth-tax authorities valuing unquoted shares
• Assessees with pending valuation proceedings on the date of the circular

The instrument, as the Board published it

Valuation of unquoted equity shares of investment companies, holding companies, etc. - Guidelines therefor

1. Reference is invited to the instructions contained in the Board’s Circular No. 2 (WT) of 1967, dated 31-10-1967 [printed here as Clarification 3] regarding valuation of unquoted equity shares of investment companies, holding companies and managing agency companies.
2. In partial modification of the above circular, the directions and instructions of the Board with regard to the valuation of unquoted equity shares of investment companies which have wholly-owned subsidiaries (i.e., investment companies having one or more companies which are itself 100 per cent subsidiaries), are as follows :
1. In arriving at the estimated price which a share of such company would fetch if sold in open market on the relevant valua­tion date, its "asset backing" must be carefully computed in accordance with well settled principles, in other words, the valuation should take into account the complete enterprise (consisting of the parent investment company and its wholly-owned subsidiary or subsidiaries) as if they were only one compa­ny. In arriving at such computation the reserves of the subsidi­ary company must necessarily be taken into account.
2. Applying the above principles :
(i) The value of a share of the parent investment company would have first to be determined on the basis that the parent investment company and its wholly-owned subsidiary or subsidi­aries were in fact one single company. This should be done by assimilating and consolidating the balance sheets of the subsidi­ary companies with the balance sheet of the parent investment company. Care must be taken to ensure that in such assimilation and consolidation, the inter-company balances are correctly adjusted.
(ii) "Maintainable profits" would have to be aggregated in respect of the parent investment company and its wholly-owned subsidiary or subsidiaries. The capitalised value should then be arrived at by applying a rate of yield of 9 per cent to the aggregated "maintainable profits". The method of calculation of "maintainable profits" in respect of the parent investment compa­ny and its wholly-owned subsidiary or subsidiaries should be in accordance with the Board’s Circular No. 2 (WT) of 1967, i.e., they should be determined separately in accordance with the said circular and then aggregated.
(iii) The average of the values arrived at under (i) and (ii) above would determine the price which the share of the parent investment company would fetch if sold in the open market on the relevant valuation date.
3. It is clarified that para 3 of Circular No. 2 (WT) of 1967 [Clarification 3] will not apply in cases of valuation of shares of a parent investment company which has a wholly-owned subsidi­ary.
4. The above instructions, which are to be read in partial modi­fication of Circular No. 2 (WT) of 1967 are to be followed and implemented in all matters with immediate effect including pend­ing proceedings.
Circular : No. 118 [F. No. 319/16/73-WT], dated 15-9-1973.

What to watch

• This is wealth-tax valuation guidance, as the file number shows, and it works on the 1967 wealth-tax circular.
• Consolidation must adjust inter-company balances, or the asset backing is overstated.
• Maintainable profits are computed separately for each company on the 1967 basis and only then added; they are not computed on consolidated accounts.
• It applies to wholly-owned subsidiaries; a partly owned subsidiary is not within these directions.
• This approach was itself displaced by Circular No. 332A dated 31 March 1982, which discarded the averaging of asset backing and capitalised yield after the Supreme Court's decision it relies on.

Where you meet it

A wealth-tax valuation of shares in a family holding company with wholly-owned subsidiaries, where the officer valued the parent alone.

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