Section 37 l Valuation of Shares in Private Company
Circular No. 328 was issued by the Central Board of Direct Taxes on 18 February 1982. Its subject is Section 37 l Valuation of Shares in Private Company.
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.
Sets out how shares in a private limited company whose articles restrict alienation are to be valued under section 37 of the Estate Duty Act. The section works in two steps: first see whether the value is ascertainable by reference to the value of the total assets of the company, and only if it is not, estimate what the shares would fetch in the open market on the footing that the purchaser can be registered subject to the articles, disregarding any higher price a special buyer would pay. Where the first limb applies, the break-up method is used on the market value of the assets, not the book value. Where the second applies, the officer need not use the break-up method and may value on yield or profits. It records that Circular No. 1-D/ED of 1968 dated 26-3-1968, which had carried the Wealth-tax Rules method over to estate duty valuation, was held by Instruction No. 771 dated 29-10-1974 not to apply to section 37 shares, the earlier letters of 3-5-1965 and 5-7-1965 governing instead. 'Total assets of the company' means market value and includes goodwill whether or not shown in the balance sheet. Where two or more private companies hold shares in each other and the break-up method is used, the value can be got by framing and solving simple equations.
A reference from Revenue Audit led the Board, after consulting the Ministry of Law on the scope of section 37, to settle which of its earlier instructions governed the valuation.
| Under the 1961 Act | Now |
|---|---|
| s.37 | s.34 |
SECTION 37 l VALUATION OF SHARES IN PRIVATE COMPANY
1543. Valuation of equity shares in a private limited company where alienation of shares is restricted - Guidelines therefor
CLARIFICATION 1
1. Section 37 deals with valuation of shares in a private company where alienation of shares is restricted. The section reads as under :
"Where the articles of association of a private company contain restrictive provisions as to the alienation of shares, the value of the shares, if not ascertainable by reference to the value of the total assets of the company, shall be estimated to be what they would fetch if they could be sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, but the fact that a special buyer would for his own special reasons give a higher price than the price in the open market shall be disregarded."
The Board in their letters dated 3-5-1965 and 5-7-1965 issued from F. No. 25A/3/65-ED [printed here as Clarifications 2 & 3] clarified the scope of this section. Briefly, the clarification runs as follows :
Section 37, which governs the mode of valuation of shares in a private limited company whose articles of association contain restrictive provisions as to the alienation of its shares, contemplates :
(a) firstly, it should be seen whether the value of shares is ascertainable by reference to the value of the total assets of the company; and
(b) if it is not so ascertainable, then it shall be estimated to be what it would fetch if sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, disregarding any special price that might be paid by a special buyer.
If clause (a) applies the value of shares should be determined by break-up method taking the market value of the assets of the company and not the book value, if that does not happen to be their market value. If clause (b) applies then the Assessing Officer need not necessarily adopt the break-up method but may also adopt some other method of valuation based on the yield or profits, etc.
2. These instructions appeared to have been impliedly modified by Circular No. 1-D/ED of 1968 which extended the method of valuation prescribed by the Wealth-tax Rules to valuation of shares for purposes of the Estate Duty Act. On a reference from the Revenue Audit, the Board, after consultation with the Ministry of Law on the scope of section 37, issued Instruction No. 771 dated 29-10-1974 directing that contents of Circular No. 1-D/ED of 1968, dated 26-3-1968 will not apply to valuation of shares covered by section 37 but that the valuation of such shares will be governed by the Board’s earlier letters dated 3-5-1965 and 5-7-1965 issued from F. No. 25A/3/65-ED [Clarifications 2 and 3]. Thus, the expression "value of the total assets of the company" in section 37 would mean market value of the assets and not the book value of the assets; further, the expression "total assets of the company" would include goodwill also, whether or not shown as such in the balance sheet.
3. An allied issue is valuation of shares in a case where two or more private companies hold shares of each other and valuation of such shares to be made by the break-up method. The Board are of the view that in such cases the value of the shares can be determined by framing and solving simple equations.
Instruction : No. 835 [F. No. 313/88/74-ED], dated 24-5-1975 [Source : 178th Report (1983-84) of the Public Accounts Committee, pp. 54-55].
CLARIFICATION 2
1. Attention is invited to the instructions on the valuation of shares, not quoted on the stock exchange, detailed in paragraph 1(c) of the Board’s Circular No. 3-WT of 1957, dated 28-9-1957. According to these instructions, the value of such shares is to be determined on the basis of the value of assets, i.e., break-up value. The method of valuation of shares in the cases of investment companies for the purposes of Wealth-tax Act has been explained in Board’s Circular No. 6-D(WT) of 1960, dated 8-8-1960.
1 2. Under the Estate Duty Act, section 37 governs the mode of valuation of shares in a private limited company where alienation is restricted. The Board desire that uniform practice should be followed by the officers on the estate duty side in this matter. In this connection, the Board would like to point out that for purposes of valuation of unquoted shares under section 37, the value to be taken into consideration should be based on the break-up value by taking the market value of the assets of the company and not the book value if that does not happen to be their market value.
Instruction : No. 25A/3/65-ED, dated 3-5-1965 [Source : 178th Report (1983-84) of the PAC].
CLARIFICATION 3
1. Section 37, which governs the mode of valuation of shares in a private limited company whose articles of association contain restrictive provisions as to the alienation of its shares contemplates :
(a) firstly, it should be seen whether the value of shares is ascertainable by reference to the value of the total assets of the company; and
(b) if it is not so ascertainable, then it shall be estimated to be what it would fetch if sold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the articles, disregarding any special price that might be paid by a special buyer.
2. The instructions issued by the Board in their circular letter referred to in para 1 above were only with regard to the first part contemplated by section 37. They do not and were not intended to restrict the application of the second part of section 37 for which purpose it would be open to the Assessing Officer to adopt some other method of valuation based on the yield of profits, etc.
Instruction : No. 25A/3/65-ED, dated 5-7-1965.1. See Clarification 3 for further clarification on this point.
In estate duty valuation disputes over unquoted shares in a closely held company with restrictive articles.
Source: the Income Tax Department’s own published text — its page for this instrument.
