Long-term capital gains on unlisted shares upheld; notional valuation and interest capitalisation issues partly rejected

For assessment year 2014-15, unlisted shares held for 23 months were treated as long-term capital assets, as the then-applicable period under section 2(42A) was 12 months and the later 36-month rule for unlisted shares operated prospectively. The Tribunal also held that section 50D could not justify substitution of a notional fair market value where the transfer consideration was ascertainable under the contractual arrangements, so the capital gains had to be recomputed on the revised per-share value. By contrast, interest on borrowings used to acquire rights shares could not be capitalised, because section 55(2)(aa)(iii) confines cost of acquisition to the amount actually paid.

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Issues: (i) Whether the sale consideration of the unlisted shares of SBPL could be substituted by a notional fair market value and whether the value per share adopted by the Revenue was sustainable; (ii) Whether interest expenditure incurred on borrowings used for acquiring the right shares of SBPL could be capitalized as part of the cost of acquisition; (iii) Whether, for assessment year 2014-15, the gains arising from sale of unlisted shares held for 23 months were to be assessed as long-term capital gains or short-term capital gains.

Issue (i): Whether the sale consideration of the unlisted shares of SBPL could be substituted by a notional fair market value and whether the value per share adopted by the Revenue was sustainable.

Analysis: The transfer price under the framework arrangements was linked to the fair market value of the underlying telecom holding structure, but section 48 requires computation on the basis of consideration received or accruing. The Tribunal held that section 50D was inapplicable because the consideration was ascertainable and determinable, and that the notional enhancement made by the Assessing Officer and upheld by the CIT(A) could not stand on that provision. The Tribunal further held that the sale consideration actually mentioned in the share purchase agreement could not alone govern the matter, because the earlier contractual arrangements created enforceable rights and obligations and the accrual had to be tested with reference to those arrangements. On valuation, the Tribunal rejected the valuation adopted by the Revenue and adopted a revised per-share value after correcting the indirect shareholding percentage and applying the valuation of the holding chain.

Conclusion: The Revenue was not entitled to sustain the substituted consideration as made in the assessment, and the capital gains were to be recomputed on the revised per-share value determined by the Tribunal.

Issue (ii): Whether interest expenditure incurred on borrowings used for acquiring the right shares of SBPL could be capitalized as part of the cost of acquisition.

Analysis: The right shares were subscribed against a specific entitlement and the cost of acquisition in such a case is governed by section 55(2)(aa)(iii), which confines the cost to the amount actually paid for acquiring the financial asset. The Tribunal held that the statutory language is exhaustive and does not permit addition of borrowing interest to the cost of acquisition of right shares. The case law relied upon by the assessee was held distinguishable in view of the specific statutory provision governing rights shares.

Conclusion: The claim for capitalization of interest as part of the cost of acquisition was rejected and the disallowance was upheld.

Issue (iii): Whether, for assessment year 2014-15, the gains arising from sale of unlisted shares held for 23 months were to be assessed as long-term capital gains or short-term capital gains.

Analysis: For the relevant assessment year, the proviso to section 2(42A) treated shares held in a company as short-term only if held for not more than 12 months, and the later amendment increasing the period for unlisted shares to 36 months operated prospectively from assessment year 2015-16. The Tribunal held that the assessee's unlisted shares, held for 23 months, fell within the long-term category under the law applicable to assessment year 2014-15.

Conclusion: The gains were correctly assessable as long-term capital gains and not as short-term capital gains.

Final Conclusion: The appeal succeeded on the characterization of the capital gains but failed on the challenge to interest capitalization, resulting in a partial relief to the assessee and a recomputation of the capital gains on the Tribunal's revised valuation basis.

Ratio Decidendi: For the assessment year in question, unlisted shares held for more than 12 months remained long-term capital assets, and where the transfer price is contractually linked to an ascertainable consideration, section 50D cannot be used to substitute a notional fair market value; however, for rights shares, section 55(2)(aa)(iii) confines cost of acquisition to the amount actually paid.

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