The final valuation rules for angel tax largely mirror the draft rules unveiled by the finance ministry in May but have provided significant relief by including provisions relating to Compulsorily Convertible Preference Shares (CCPS) that would help in funding from venture capital funds and foreign investors.
Experts have welcomed the final rules that provide clarity and flexibility for valuation of foreign investments in unlisted companies at a premium but there remain some concerns about how it will be implemented.
The final rules, that were notified by the Central Board of Direct Taxes and come into effect from September 25, have retained the five valuation norms provided in the draft rules including Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, and Replacement Cost Method.
The final rules have however, introduced a mechanism for arriving at the fair market value of Compulsorily Convertible Preference Shares (CCPS) for investment from residents as well as non-resident residents. These instruments are seen as a key element of fund raising by start-ups.
The rules have provided that the valuation of CCPS can also be based on the fair market value of unquoted equity shares. The draft rule had also provided that where the date of merchant banker's valuation report is not more than 90 prior to the date of issue of shares then the date can be deemed be the valuation date if the assessee so chooses. The final rule has said that if such an option is exercised, the provisions of Rule 11U(j) shall not apply. It also provides for the 10 per cent safe harbour which applies to the valuation of both unquoted equity shares and CCPS where the issue price of the shares exceeds the value of shares.
Experts said the rules will provide some help to investors but there could be some legal battles over the valuation norms.
Subramaniam Krishnan, Partner, Private Equity Tax, EY India called the final rules as welcome changes in comparison with the draft rules released in May 2023. “The extension of the valuation methods, the 10% safe harbour, comparable transaction-based pricing to CCPS provides the desired flexibility given that a substantial number of transactions in Indian companies are structured in the form of investments in such convertible instruments,” he noted.
Sumit Singhania, Partner, Deloitte India said from the standpoint of investors, the revised rules offer wider range of valuation methodologies to work with, and that ought to make compliance less onerous. “Also, safe harbour permitting 10% deviation from fair value makes room for valuation adjustments when needed. Overall, the trajectory is to align tax valuation methodologies with permissible exchange control norms,” he said.
Amit Maheshwari, Tax Partner, AKM Global, a tax and consulting firm noted that the new angel tax rules have very well taken care of an important aspect of CCPS valuation mechanism which was not the case earlier since most of the investments in India by venture capital funds is through the CCPS route only. “However, the implementation would be interesting to watch since valuation is a subjective matter and a variety of valuation methods may be used with different approaches, which can potentially increase the litigation risks,” he cautioned.
Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen LLP, also noted that while there have been efforts to address certain concerns it remains evident that anomalies and confusion persist within the community. “For instance, it does not adequately tackle the challenges associated with the price-matching mechanism, which could potentially lead to capital dilution and practical implementation difficulties,” he said, adding that the longstanding issues related to valuation continue to cast a shadow, with the Revenue Authorities consistently scrutinising assumptions made by taxpayers during valuation, questioning the chosen valuation methods, and limiting the taxpayer's flexibility to opt for alternate mechanisms, despite the legal provisions allowing for such flexibility. He also noted that the safe harbour of 10% may not provide aid in deal dynamics and jeopardize the investments from foreign investors.
The Union Budget 2023-24 amended Section 56(2) viib of the Income Tax Act and from April 1, this year unlisted companies issuing shares at a premium to non-residents exceeding the fair market value are to be taxed at a rate of 30.6 per cent. Called angel tax, it is seen to largely impact start-ups. However, businesses incorporated prior to April 2016 and Sebi-registered alternative investment funds (AIFs) are exempt from the provision. Start-ups registered with the DPIIT will also be exempt.
Also Read: Wealth management in India will quadruple in the coming decade: Nuvama Group MD & CEO Ashish Kehair