What Are the Tax Consequences of Settling a Loan by Transferring Unlisted Shares?

Consider a borrower who owes a non-banking financial company (NBFC) an unsecured loan he cannot repay in cash, but who holds unlisted equity shares worth roughly the outstanding amount. The parties agree to settle in kind: the borrower transfers the shares to the NBFC at fair market value (FMV), and the consideration is set off against the loan. No money changes hands, yet Indian income tax law sees a taxable event on each side of the table - capital gains for the borrower under Sections 45, 48 and 50CA of the Income Tax Act 1961, and, if the numbers diverge, deemed income for the lender under Section 56(2)(x). Whether the settlement is tax-efficient or doubly taxed turns almost entirely on one variable: how the loan amount compares with the shares' FMV determined under the valuation rules.

Why a Set-Off Is Still a "Transfer"

Section 2(47) of the Act defines "transfer" in relation to a capital asset in deliberately broad terms, covering

"the sale, exchange or relinquishment of the asset; or the extinguishment of any rights therein"

and clarifying, for the removal of doubts, that transfer includes "disposing of or parting with an asset or any interest therein... directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement... or otherwise." The absence of cash consideration is irrelevant. A conveyance of unlisted shares against extinguishment of a debt is an exchange, and therefore a transfer under Section 2(47), triggering capital gains taxation under Section 45 in the year the transfer takes place. The substance of the transaction, not the label the parties give it, determines taxability.

The Extinguished Loan Is the Consideration

Section 48 computes the capital gain by deducting from the "full value of consideration received or accruing as a result of the transfer" the cost of acquisition, cost of improvement and transfer expenses. Consideration is not confined to cash: it includes any benefit that increases the transferor's financial capacity or reduces a financial burden. Courts and tribunals have accepted that discharge of a debt can be valid consideration; the Himachal Pradesh High Court in IA Hydro Energy (P) Limited, dealing with the conversion of loans into equity, respected the transaction where the books had been accepted in the year the loan was received and the Revenue could not show the conversion was a scheme to defraud. The principle carries over: extinguishment of a loan liability through an asset transfer is a recognized form of consideration.

Timing follows the word "accruing": the consideration accrues on the date of transfer, when the right to the discharge arises - not when the loan was originally advanced. The borrower's computation is therefore:

Capital gain = consideration (the loan set off, or the deemed FMV under Section 50CA) − cost of acquisition − transfer expenses.

Section 50CA: The Statutory Floor Under the Seller's Price

For unlisted shares, the parties' agreed price is not the last word. Section 50CA, an anti-undervaluation provision, states:

"Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration."

Three features matter. First, the section applies only to unquoted shares; listed shares are outside it. Second, it is triggered only where the actual consideration is less than the prescribed FMV; if the consideration equals or exceeds FMV, Section 50CA is dormant. Third, the FMV is determined under Rule 11UAA of the Income-tax Rules 1962, which for unquoted equity shares prescribes a net-asset-value formula - book value of assets, with jewellery, artistic work, shares and securities taken at fair market value and immovable property at stamp duty value, less book liabilities, apportioned across paid-up equity capital - or, alternatively, a merchant banker or accountant valuation using accepted methodologies such as discounted cash flow.

Applied to the loan settlement: if the loan being set off equals the independently determined FMV, Section 50CA never engages. But if the outstanding loan is lower than the Rule 11UAA value, the FMV is substituted as deemed consideration. The memo's illustration: shares acquired for ₹50 lakh, valued at ₹150 lakh under Rule 11UAA, transferred against a loan balance of ₹120 lakh. Section 50CA deems the consideration to be ₹150 lakh, producing a gain of ₹100 lakh - tax on ₹30 lakh the borrower never received, in a transaction that generates no cash with which to pay it. This "dry tax" risk is the seller-side heart of the problem.

Relief exists only at the margins. Rule 11UAD, framed under powers conferred by the Finance Act 2019, disapplies Section 50CA (and Section 56(2)(x)) for narrow classes of transactions - shares transferred under NCLT-approved resolution plans for stressed companies and allotments under the Yes Bank Reconstruction Scheme 2020 - where an authority has itself approved the consideration. An ordinary loan settlement between a borrower and an NBFC falls within no such safe harbour.

Holding Period Decides the Rate

The rate applied to the borrower's gain depends on classification under Section 2(42A). For unlisted shares the long-term threshold is 24 months, counted from acquisition (allotment or purchase, as recorded in the register of members or demat account) to the date immediately preceding the transfer.

The Finance Act 2024 reset the rates with effect from 23 July 2024. Long-term gains on unlisted shares are now taxed at a flat 12.5 per cent without indexation - the indexation benefit that previously accompanied the 20 per cent rate was removed for transfers on or after that date. Short-term gains (holding of 24 months or less) are added to total income and taxed at slab rates, which can reach 30 per cent plus surcharge and cess. The gap between 12.5 per cent and a 30 per cent slab makes the holding period the single most consequential fact in the borrower's computation: where a proposed settlement falls close to the 24-month line, the timing of the transfer can change the tax bill dramatically.

The Lender's Exposure: Section 56(2)(x)

The NBFC's side of the transaction is governed by Section 56(2)(x), which charges to tax, as income from other sources, the receipt of property either without consideration or for consideration less than its FMV (computed under Rule 11UA) by more than ₹50,000. For movable property including shares, the charge is on the difference between FMV and the consideration paid.

Two boundary points from CBDT practice frame its application here. The provision is aimed at the receipt of property: mere cancellation or set-off of debts, with no property changing hands, is outside it. And CBDT Circular 3/2019 clarifies that the charge does not extend to a fresh allotment of shares by a company - it targets acquisition of existing shares below FMV. In the loan settlement, the NBFC receives existing shares from the borrower, so Section 56(2)(x) is squarely in play.

Whether it actually bites is, again, arithmetic. If the shares come in at their documented FMV - consideration (the loan set off) equal to the Rule 11UA value - the differential is nil and no deemed income arises. If the FMV exceeds the loan amount by more than ₹50,000, the difference is taxable in the NBFC's hands at its corporate rate. Unlike individuals, an NBFC has no recourse to the reinvestment exemptions in Sections 54, 54F or 54EC. The same Rule 11UAD carve-outs noted above exist, and the same conclusion follows: an ordinary loan settlement does not qualify.

When Both Sections Bite: The Double Taxation Problem

The uncomfortable feature of this structure is that Sections 50CA and 56(2)(x) are mirror images that can fire simultaneously on the same valuation gap. If the loan set off is below the prescribed FMV, the borrower is taxed on gains computed at the higher deemed FMV, and the NBFC is taxed on the FMV-to-consideration differential as deemed income. Both parties pay tax on substantially the same spread. The CBDT has acknowledged that FMV deeming can cause "genuine hardship" - that acknowledgment produced Rule 11UAD - but the relief was confined to regulated, authority-approved transactions and does not reach private settlements.

The memo's scenario analysis makes the interaction concrete (LTCG at 12.5 per cent; slab and corporate rates assumed at 30 per cent):

Scenario B is the trap: a ₹40 lakh valuation spread produces ₹33 lakh of combined tax across the two parties, and the borrower additionally bears STCG at slab rates because the 24-month threshold was missed by four months. Scenario C - shares worth less than the loan - is commercially rare (a lender would seldom accept it in full settlement), but it illustrates that the deeming provisions operate in one direction only: the borrower is still taxed on the full loan amount as consideration, while neither Section 50CA nor Section 56(2)(x) applies.

Where a gap between FMV and the loan amount emerges from the valuation, the parties' realistic options are to renegotiate the set-off amount to match the FMV (eliminating both triggers), to accept and budget for the combined tax cost, or to restructure - for instance, part payment in cash alongside partial discharge.

Withholding, Disclosure and the Buyer's Cost Basis

No tax is required to be deducted or collected at source on the transfer itself: Section 194Q as enacted is focused on listed securities, and the TCS provision in Section 206C(1H) concerns goods, not shares - though the memo notes no authoritative source directly on the point, and the position rests on standard interpretation of those provisions. Disclosure obligations remain: the borrower reports the transfer, the computation and (where Section 50CA applies) the FMV in Schedule CG of the return; the NBFC reports any Section 56(2)(x) deemed income under Schedule OS of its corporate return.

For the NBFC's future tax position, the cost of acquisition of the shares is the consideration paid - the loan amount set off - which will be the base for computing capital gains on any later sale under Sections 48 and 49. Records should fix the acquisition date, the set-off amount and the valuation relied on, since a subsequent disposal (or a later assessment notice on the deemed-income point) will be tested against that paper trail. Given the interpretive gaps - there is no CBDT circular squarely addressing loan settlement through in-kind share transfer - the parties may also consider seeking an advance ruling before executing the transaction, which binds both the applicant and the Revenue for the specified transaction and buys certainty that the general provisions do not.

A final doctrinal anchor: the Supreme Court has long held that the name the parties give a transaction does not decide its nature - "the question always is what is the real character of the payment, not what the parties call it." That cuts both ways. The Revenue cannot ignore that property genuinely passed and a debt was genuinely discharged; the parties, equally, cannot paper over a below-FMV transfer by reciting that it occurred at FMV. What protects the transaction is not drafting but evidence: an arm's-length negotiation, a contemporaneous independent valuation, and a documented commercial rationale.

Practical Takeaways

• Value first, settle second. Commission a Rule 11UA/11UAA valuation from a merchant banker or chartered accountant, contemporaneous with the transfer date, before fixing the set-off amount - and document the valuation independently of the loan figure so it cannot be dismissed as reverse-engineered.
• Align the set-off with the FMV. If consideration equals or exceeds the prescribed FMV, both Section 50CA and Section 56(2)(x) fall away. Every rupee of shortfall is potentially taxed twice.
• Check the calendar. Twenty-four months separates slab-rate STCG (up to 30 per cent) from 12.5 per cent LTCG. A transfer close to the threshold deserves a timing review; indexation is no longer available for transfers on or after 23 July 2024.
• Budget for dry tax. The borrower may owe capital gains tax without receiving any cash; the funds must come from elsewhere. The NBFC should likewise provision for deemed income if the valuation exceeds the loan.
• Paper the transaction. The agreement should state the consideration as extinguishment of the specified loan balance as at the transfer date, annex the valuation report, and preserve loan records evidencing the outstanding amount.
• Regulatory clearance runs separately. The NBFC should clear the acquisition with its RBI/compliance function - the settled loan becomes an equity investment for prudential classification and provisioning purposes - and obtain warranties that the shares are unencumbered.
• Consider an advance ruling where the amounts justify it, given the absence of specific CBDT guidance on in-kind loan settlements.

Key Authorities

1. Income Tax Act 1961, Section 2(47) - definition of "transfer", covering exchange and extinguishment of rights. Source
2. Income Tax Act 1961, Sections 45 and 48 - charge of capital gains and mode of computation. Source
3. Income Tax Act 1961, Section 50CA - FMV deemed to be the consideration on transfer of unquoted shares below fair market value.
4. Income Tax Act 1961, Section 56(2)(x) - receipt of property for inadequate consideration taxed as income from other sources.
5. Income Tax Act 1961, Section 2(42A) - 24-month holding period threshold for unlisted shares; Finance Act 2024 rate changes effective 23 July 2024. Source
6. Income-tax Rules 1962, Rules 11UA and 11UAA - prescribed FMV methodology for unquoted equity shares. Source
7. Income-tax Rules 1962, Rule 11UAD - exemptions from Sections 50CA and 56(2)(x) for NCLT-approved resolution plans and the Yes Bank Reconstruction Scheme 2020. Source
8. CBDT Circular 3/2019 - Section 56(2)(x) inapplicable to fresh allotment of shares, as distinct from acquisition of existing shares.
9. IA Hydro Energy (P) Limited (Himachal Pradesh High Court) - loan-to-equity conversion respected; Revenue cannot recharacterize a documented, non-fraudulent transaction. Source

This analysis reflects the law as at June 2026. It is published for general information and does not constitute legal advice.