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Angel Tax Methods

Following extensive public consultations, the Central Board of Direct Taxes (CBDT) has formally introduced the revised Rule 11UA for foreign investments in startups based in India. These revisions are a response to the inclusion of non-resident investments in Section 56(2)(vii)(b) of the Income-tax Act 1961, commonly referred to as the 'angel tax' provision, by the Finance Act of 2023.

The objective of these changes is to tackle concerns related to disputes over valuation with tax departments for funds raised by Indian companies. Effective from September 25, 2023, these rules offer investors the flexibility to choose from five newly introduced valuation methods, in addition to the discounted cash flow and net asset value methods, for determining angel tax implications under Section 56(2)(vii)(b) of India’s Income-tax Act 1961.

The 'angel tax', which imposes income tax at a rate of 30.6 percent, will be applicable when an unlisted company allocates shares to an investor at a value surpassing its fair market worth. These updated regulations will come into effect on September 25, 2023.

In layman's terms, angel tax is a tax imposed on the funds generated through the issuance of shares by unlisted companies if the share price exceeds the fair market value of the company determined by the prescribed methods.

Any amount exceeding this, after factoring in a 10 percent margin, will be considered as a "taxable premium".

The revised regulations also uphold the inclusion of the five additional valuation approaches outlined in the initial draft for assessing funds received from non-resident entities viz.,

  • Comparable Company Multiple Method
  • Probability Weighted Expected Return Method
  • Option Pricing Method
  • Milestone Analysis Method
  • Replacement Cost Methods


Comparable Companies Multiples ("CCM") Method

The Comparable Companies Multiples method, also known as the Market Approach, is a valuation technique used to determine the value of a company by comparing the financial metrics (such as Price to Earnings ratio, Price to Sales ratio, etc.) of the target company with those of similar publicly traded companies in the same industry. This method assumes that companies with similar financial characteristics should have similar market valuations. By applying the multiples derived from comparable companies to the target company's financial metrics, an estimated value can be obtained. This approach is particularly useful when there is a robust set of comparable companies available for analysis.

Example of Comparable Companies Multiples method: -

Let's assume Company X has an annual net income of $1 million & Company A, Company B, and Company C are publicly traded companies in the same sector that are similar in size, market focus, and financial performance to Company X.

Let’s assume P/E ratio of Company A, Company B and Company C is –

  • Company A has a P/E ratio of 20.
  • Company B has a P/E ratio of 25.
  • Company C has a P/E ratio of 18.

The average P/E ratio of the comparable companies:

Average P/E Ratio = (20+25+18)/3 = 21

Company X's value using the P/E ratio method:

Estimated Value = Average P/E Ratio × Company X′s Earnings

Estimated Value = 21 × $1,000,000 = $21,000,000

So, based on this simplified example, using the Comparable Companies Multiples method with the P/E ratio, Company X would be estimated to be worth approximately $21 million.


Probability Weighted Expected Return Method

The Probability Weighted Expected Return method is a financial valuation technique used to estimate the expected return of an investment or project with multiple potential outcomes or scenarios. It considers both the probability of each scenario occurring and the corresponding expected return associated with that scenario.

Here's how it works:

  1. Identify Scenarios: First, various scenarios or outcomes for the investment or project are identified. These scenarios can range from highly optimistic to highly pessimistic, representing different possible future states.
  2. Assign Probabilities: Each scenario is assigned a probability, indicating the likelihood of that scenario occurring. These probabilities should sum up to 100% to represent all possible outcomes.
  3. Calculate Expected Returns: For each scenario, calculate the expected return. This is typically done by multiplying the probability of the scenario by the return that would be generated if that scenario occurs.
  4. Summation: Sum up all the expected returns from different scenarios to obtain the Probability Weighted Expected Return.


This method is especially useful for evaluating projects or investments with uncertain outcomes, as it provides a more nuanced and realistic view of the potential returns. It helps decision-makers make informed choices by considering both the range of possible outcomes and their respective probabilities.

The primary benefit of the PWERM:

  • This method allows the valuation specialist to make specific assumptions about the timing, range, and outcomes from specific future events, such as lower or higher values for a strategic sale versus an IPO. 


Probability Weighted Expected Return Method works well in industries like finance industry, including sectors such as asset management, hedge funds, and private equity, Real estate investment, Venture Capital & Private Equity, Risk Management & Insurance, Commodities & futures trading, Project Finance, Options & Derivatives Trading, Natural Resources and Mining.

Overall, the Probability Weighted Expected Return Method is particularly suitable in industries and sectors where there is a high degree of uncertainty and where investment decisions are influenced by a range of potential outcomes. It helps investors and decision-makers make more informed choices by quantifying the expected returns and risks associated with different scenarios.

Example of Probability Weighted Expected Return Method: -

Let's say you're considering investing in a startup company, and you want to use the PWERM method to estimate its value. The company is developing a new mobile app, and there are two main scenarios:

Now, estimate the possible outcomes from different scenarios –

Successful Launch Scenario:

  • Optimistic Outcome: If the app is highly successful, it could generate a net profit of $1 million per year.
  • Pessimistic Outcome: If the success is moderate, it might generate a net profit of $500,000 per year.

Unsuccessful Launch Scenario:

  • Optimistic Outcome: Even in an unsuccessful scenario, there could still be some revenue. Let's say it generates a net profit of $100,000 per year.
  • Pessimistic Outcome: If it's a complete failure, there may be no revenue generated.

Next, calculate the expected returns for each scenario by multiplying the probability by the respective outcome:

Successful Launch Scenario:

  • Optimistic Expected Return: 0.6×$1,000,000 = $600,000
  • Pessimistic Expected Return: 0.4×$500,000 = $200,000

Unsuccessful Launch Scenario:

  • Optimistic Expected Return: 0.4×$100,000 = $40,000
  • Pessimistic Expected Return: 0.6×$0 = $0

Finally, sum up all the expected returns from each scenario to get the overall estimated value of the investment:

Estimated Value = $600,000+$200,000+$40,000+$0=$840,000

So, based on this simplified example, using the Probability Weighted Expected Return Method, the startup company would be estimated to be worth approximately $840,000.

Option Pricing Method (OPM)

Option Pricing Method is a financial valuation approach used to determine the fair value of options, which are financial instruments that give the holder the right (but not the obligation) to buy or sell an underlying asset at a specified price within a specific time frame. There are various methods within this category, with the most common being:

  • Black-Scholes Model: Developed by economists Fischer Black and Myron Scholes, this model is widely used to estimate the theoretical price of European-style options. It takes into account factors such as the current stock price, option strike price, time to expiration, risk-free interest rate, and volatility of the underlying asset.
  • Binomial Model: This method divides time into discrete intervals and models the potential future prices of the underlying asset, considering both up and down movements. It is particularly useful for valuing American-style options, which can be exercised at any time before expiration.
  • Trinomial Model: Similar to the binomial model, but it allows for three possible price movements (up, down, and no change) in each time interval. This model can provide more accurate valuations for options with more complex features.
  • Monte Carlo Simulation: This method involves running multiple simulations of possible future scenarios, considering various factors like price movements, interest rates, and volatility. It provides a range of potential option values.
  • Real Options Valuation: This approach extends option pricing to non-financial contexts, allowing for the valuation of real-world projects with option-like features, such as the option to expand or abandon a project.

Each of these methods has its own set of assumptions and complexities, making them suitable for different types of options and market conditions. The choice of method depends on the specific circumstances and characteristics of the option being valued.

Example of Option Pricing Method: -

Let's consider a call option, which gives the holder the right to buy 100 shares of a certain company's stock at a strike price (K) of $50 per share. The current market price of the stock (S) is $60 per share, Time until expiration (T) = 3 months (0.25 years), Risk-free interest rate (r) = 5% and Volatility (σ) = 20%.

Using these parameters & by using the Black-Scholes model of option pricing method, the value of the call option can be determined as:

C = S*N(d1) – K*e −rT * N(d2)

Plug in the values:

d1 = 0.6976

d2 = 0.4976

N(d1) = 0.7550

N(d2) = 0.6915

C = (60*0.7550) − (50*e−0.05*0.25 * 0.6915) = 40.20

So, based on this simplified example and the Black-Scholes model, the value of the call option is approximately $40.20.

Weighted Milestone Method (WMM) or Earned Value Method (EVM)

The Weighted Milestone Method and the Earned Value Method are both project valuation techniques used in project management and can also be adapted for company valuation. Here's a brief overview of each method:

Weighted Milestone Method:

The Weighted Milestone Method involves assigning weight to specific milestones or achievements within a project or, in this case, the company. The valuation is then based on the completion of these milestones. Here are the steps to perform a company valuation using this method:

  • Identify Key Milestones: Determine the significant achievements or milestones that are relevant to the company's valuation. These could include product launches, market expansions, revenue targets, etc.
  • Assign Weights: Assign a percentage or weight to each milestone based on its relative importance. For example, a product launch might be assigned a higher weight than a minor operational improvement.
  • Track Progress: Monitor and track the progress of the company in achieving these milestones. This could involve regular updates and assessments.
  • Calculate Valuation: As milestones are achieved, multiply the weight assigned to each milestone by the actual achievement percentage. Sum up these values to get the weighted milestone value.

Example of Weighted Milestone Method:

Let's say you're considering investing in a startup company, and you want to use the Weighted Milestone Method to estimate its value. The company is developing a new mobile app, and there are three key milestones that need to be achieved for it to succeed:

  1. Successful Product Development (40% probability): If the product is successfully developed, the startup would have a functional app with potential for user adoption. This might be valued at $500,000.
  2. User Acquisition (30% probability): If the startup successfully acquires a substantial user base, it will increase the value further, let's say to $1 million.
  3. Revenue Generation (30% probability): If the startup starts generating revenue, it could significantly enhance its value. Let's estimate this at $2 million.

Next, calculate the weighted value for each milestone by multiplying the probability by the respective outcome:

  • Successful Product Development: 0.4×$500,000=$200,000
  • User Acquisition: 0.3×$1,000,000=$300,000
  • Revenue Generation: 0.3×$2,000,000=$600,000

Finally, sum up all the weighted values to get the overall estimated value of the startup:

Estimated Value=$200,000+$300,000+$600,000=$1,100,000

So, based on this simplified example, using the Weighted Milestone Method, the startup would be estimated to be worth approximately $1.1 million.

Earned Value Method:

The Earned Value Method is a project management technique used to assess a project's progress in monetary terms. It compares the planned value (budgeted cost of work scheduled, BCWS) with the earned value (budgeted cost of work performed, BCWP) and the actual cost (actual cost of work performed, ACWP). Here's how you can adapt this for company valuation:

  1. Identify Metrics: Define the key performance metrics that are relevant to your company's valuation. These could include revenue, profit margins, customer acquisition costs, etc.
  2. Set Baselines: Establish the planned values or targets for these metrics. These could be based on historical data, industry benchmarks, or strategic goals.
  3. Track Progress: Regularly update and record the actual performance metrics. This could be done on a monthly or quarterly basis.
  4. Calculate Earned Value: Compare the actual performance against the planned values. Calculate the Earned Value (EV), Planned Value (PV), and Actual Cost (AC) for each metric.
  5. Assess Variance: Analyze the variance between EV, PV, and AC. Positive variances indicate that the company is performing better than planned, while negative variances indicate underperformance.
  6. Adjust Valuation: Use the earned value data to adjust the company's valuation. Positive variances might increase the valuation, while negative variances might decrease it.

Remember, both of these methods have their strengths and weaknesses, and the choice between them should be based on the nature of the company, the availability of data, and the specific objectives of the valuation.

Example of Earned Value Method:

Suppose you're managing a construction project to build a new office building. The project is expected to take 12 months, and the budget is set at $1,000,000.

After 3 months, you evaluate the progress. According to the project plan, you should have completed 25% of the work, which corresponds to $250,000 in value.

However, when you assess the actual progress, you find that you've only completed 20% of the work, which translates to $200,000.

So, by using the Earned Value Method, we will calculate as follows.

Planned Value (PV) = $1,000,000 × 25% = $250,000

Earned Value (EV) = $1,000,000 × 20% = $200,000

Let's assume the actual cost incurred is $220,000.

Cost Variance (CV) = EV - Actual Cost (AC) = $200,000 - $220,000 = -$20,000

A negative CV indicates that the project is over budget.

Schedule Variance (SV) = EV – PV = $200,000 - $250,000 = -$50,000

A negative SV indicates that the project is behind schedule.

Based on these calculations, you can conclude that after 3 months, the project is over budget by $20,000 and behind schedule by $50,000.

Replacement Cost Method

The Replacement Cost Method is a valuation approach used in real estate and accounting to determine the value of an asset or property. It involves calculating the cost to replace an existing asset with a similar one at current market prices. This method is commonly applied to estimate the value of buildings or other structures.

Here's how the Replacement Cost Method typically works:


  1. Assessment of Current Market Prices: The first step is to determine the current market prices of materials, labor, and other inputs required to construct a similar asset.
  2. Estimation of Depreciation: The next step is to consider any depreciation that has occurred in the existing asset. Depreciation accounts for the wear and tear, obsolescence, and aging of the asset. This can be calculated based on factors like the age of the asset and its remaining useful life.
  3. Calculation of Replacement Cost: The replacement cost is calculated by adding the cost of construction (materials and labor) to the estimated cost of any additional expenses such as permits, fees, and other associated costs.
  4. Adjustment for Depreciation: The calculated replacement cost is then adjusted for depreciation. This adjustment considers the age and condition of the existing asset.
  5. Final Valuation: The final value obtained after adjusting for depreciation is considered the estimated replacement cost of the asset.

It's important to note that this method assumes that the replacement asset would have similar functionality, quality, and features as the existing asset. Additionally, it does not take into account factors such as market demand, location-specific factors, or any unique attributes of the existing asset that may affect its market value

The Replacement Cost Method is particularly useful when valuing specialized properties, historical buildings, or in situations where there is limited comparable sales data available. However, it may not always reflect the true market value of the asset, especially in cases where market conditions have changed significantly since the original construction.


Example of Replacement Cost Method: -

  • Suppose a company bought machinery for $ 2,500 ten years ago. The company must decide whether it is good to replace the machinery and buy new one or continue with the old one. The present value of the machinery is $1,000 after depreciation. Suppose the replacement cost for that machinery comes out to be $2,000.
  • In this case, the management should replace the machinery since it will add value to the business in the future.
  • A company has been using its machinery for several years, and the book value of the asset is $ 5,000. The remaining useful life of the asset is two years now. If, after two years, the asset value becomes $ 8,000, and the discount rate is 5%, the present value of the replacement cost will be $ 8,000 / (1.05) * (1.05) = $ 7,256.