GOVERNMENT NOTIFIED RULES FOR VALUATION METHODS

New Delhi, Sep 26 (BUREAU REPORTER) The Income Tax Department has notified new angel tax rules that comprise a mechanism to evaluate the shares issued by unlisted startups to investors.

While previously the angel tax – a tax levied on capital received on the sale of shares of a startup above the fair market value – applied only to local investors, the Budget for 2023-24 fiscal (April 2023 to March 2024) widened its ambit to include foreign investments.

As per the Budget, the excess premium will be considered as ‘income from sources’ and taxed at the rate of up to over 30 per cent. However, startups registered by the DPIIT are exempt from the new norms.

The Finance Ministry has notified final rules on the valuation methods for non-resident and resident investors under the new angel tax mechanism in the Finance Act, 2023. Besides the rules mentioned in the draft issued in May, the notification has introduced a sub-clause ad- dressing Compulsorily Convertible Preference Shares (CCPS). Angel tax (income tax at the rate of 30.6 per cent) is levied when an unlisted company issues shares to an investor at a price higher than its fair market value (FMV). Earlier, it was imposed only on investments made by a resident investor. But Budget 2023-24 proposes to extend the angel tax also to non-resident investors from April 1, 2024.

The Finance Ministry has notified final rules outlining valuation methods for non-resident and resident investors under the new angel tax mechanism in the Finance Act 2023. Besides the rules mentioned in the draft issued in May, the notification has introduced an additional sub-clause addressing Compulsorily Convertible Preference Shares (CCPS).

Angel tax (income tax at the rate of 30.6 per cent) is levied when an unlisted company issues shares to an investor at a price higher than its fair market value (FMV). Earlier, it was imposed only on investments made by a resident investor. But Budget 2023-24 proposed to extend angel tax even to non-resident investors from April 1, 2024.

Besides the discounted cash flow (DCF) method for resident investors, the new rule prescribes five methods for non-resident investors – comparable company multiple method, probability weighted expected return method, option pricing method, milestone analysis method and replacement cost methods.

The amended rules also retain the five new valuation methods proposed in the draft rules for consideration received from the non-residents —

(i) Comparable Company Multiple Method,

(ii) Probability Weighted Expected Return Method,

(iii) Option Pricing Method,

(iv) Milestone Analysis Method, and

(v) Replacement Cost Method.

A reliable source said from an investors’ standpoint, revised rules offer a wider range of valuation methodologies to work with, and that ought to make compliance less onerous henceforth.

POINTS TO PONDER • Amendments to Rule 11UA notified, the draft made public in May retained

A mechanism for arriving at the fair market value of Compulsorily Convertible angel investor Preference Shares for investment from residents as well as non-resident residents introduced

Valuation of CCPS can also be based on the fair market value of unquoted equity shares • According to the amended rules, the ‘issue price’ shall mean the consideration received by the company for one share.

Fair market value
When a company receives any consideration for the issue of shares from a non-resident entity notified by the Centre, the price of the equity shares corresponding to such consideration may be taken as the (FMV of the equity shares for resident and non-resident investors.

On similar lines, price matching for resident and non-resident investors will be available with reference to investment by venture capital funds or specified funds. It has been proposed that the valuation report by the merchant banker for this rule will be acceptable if it is of a date not more than 90 days prior to the date of issue of shares, which are the subject matter of valuation.

‘Safe harbor’ provision
Further, to account for forex fluctuations, bidding processes and variations in other economic indicators, which may affect the valuation of the unquoted equity shares during multiple rounds of investment, rule has prescribed provision of a safe harbor of 10 per cent variation in value.

According to the notification, the valuation of CCPS can also be based on the fair market value of unquoted equity shares. It has been provided that where the date of merchant banker’s valuation report is not more than 90 prior to the date of issue of shares under valuation then such date can be deemed be the valuation date if the assessee so chooses.

FOREX SAFETY NET

Further, to account for forex fluctuations, bidding processes and variations in other economic indicators, which may affect the valuation of the unquoted equity shares during multiple rounds of investment, the rules prescribe a safe harbor provision of 10 per cent variation in value. According to the notification, the valuation of CCPS can also be based on the FMV of the unquoted equity shares, If the merchant banker’s valuation report is not more than 90 prior to the date of issue of shares, then such date can be deemed the valuation date if the assessee so chooses, CCPS VALUATION Commenting on the notification, Amit Maheshwari, Tax Partner with tax ad consulting firm AKM Global, said new rules have taken care of an important aspect of the valuation mechanism of CCPS, which is a key route for VC funds. “The extension of 10 per cent safe-harbor provision to CCPS investments, which was earlier meant for equity shares, will give the ne- cessary margin of safety for taking care of foreign ex- change fluctuations,” he said.

RELIEF TO START-UPS

Gaurav VK Singhvi, Co- Founder of We Founder Circle, said the 10 per cent safe-harbour benefit to in- vestments made in CCPS means that start-ups can raise funds through both equity and convertible preference shares up to a certain limit (10 per cent of the FMV of their shares), and these investments will not be subject to angel tax so long as they meet the criteria outlined in the safe-harbour provision. “It provides relief to start-ups and investors by reducing the tax burden,” he said.

The main highlights of the changes in Rule 11 UA are:
a) In addition to the two methods for valuation of shares, namely, Discounted Cash Flow (DCF) and Net Asset Value (NAV) method, available to residents under Rule 11UA, five more valuation methods have been made available for non-resident investors, namely, Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, Replacement Cost Method.

b) Where any consideration is received for issue of shares from any non-resident entity notified by the Central Govt., the price of the equity shares corresponding to such consideration may be taken as the FMV of the equity shares for resident and non-resident investors, subject to the following:

(i) To the extent the consideration from such FMV does not exceed the aggregate consideration that is received from the notified entity, and

(ii) The consideration has been received by the company from the notified entity within a period of ninety days before or after the date of issue of shares which are the subject matter of valuation.

c) On similar lines, price matching for resident and non-resident investors would be available with reference to investment by Venture Capital Funds or Specified Funds.

d) Valuation methods for calculating the FMV of Compulsorily Convertible Preference Shares(CCPS) have also been provided.

e) A safe harbor of 10% variation in value has been provided.

The notified Rule provides for expansion of the valuation methodologies to include globally accepted methodology and provide a broad parity to resident and non-resident investors.

READ FULL PRESS RELEASE OF CBDT proposed changes to Rule 11UA in respect of ANGEL TAX