The new valuation methods proposed by the income tax department for computation of fair market value (FMV) for angel tax is expected to provide flexibility to investors. Experts, however, said implementation would be the key to these measures as valuation can often be subjective and called for some more leeway for investments into domestic startups through compulsorily convertible preference shares (CCPS).
The Central Board of Direct Taxes (CBDT) had on May 26 invited comments on the draft rules relating to the method of computation of FMV of unquoted equity shares for the purpose of angel tax. It has sought comments from the public by June 5.
According to the draft notification, the book value or net asset value method and valuation by a merchant banker using the discounted free cash flow (DCF) method can be used for resident as well as non-resident investors.
It has also proposed two more methods for both resident and non-resident investors including valuation at which a venture capital fund and specified fund has invested in a venture capital undertaking as well as valuation at which a specified entity has invested in the company.
For non resident investors, the CBDT has proposed that the merchant banker can determine the valuation based on any five methods including Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method and Replacement Cost Methods.
The valuation undertaken by a merchant banker within 90 days of the investments would be accepted.
Additionally, a 10% leeway is provided where investment valuation is 10% more than the valuation determined. This is expected to help meet any fluctuations in foreign exchange or economic situation.
“The harmonisation of valuation rules with internationally accepted methods of valuation denote alignment of India’s tax valuation rules with global best practices in taxation and regulatory frameworks,” said Amit Agarwal, partner, Nangia & Co. The new valuation methods are likely to bridge the gap between the valuation rules outlined in the FEMA regulations and the income tax rules, he further said.
Sandeep Sehgal, partner-tax, AKM Global, said the draft rules seem to provide more flexibility to the companies raising capital but said the key would be implementation since valuation is a subjective matter and the valuers may have different approaches to apply a particular method.
For example, Comparable Company Multiple Method is one of the proposed methods. There are several transfer pricing litigations, especially on the difference of opinion between the taxpayers and the tax department on the kind and size of comparables selected.
Similar, would be the case of Replacement Cost Methods where each valuer may have a different opinion on Replacement Cost. Hence, such litigations are sure to arise with regard to valuations as well.
“The safe harbour of 10% provided for higher allotment from the FMV is very welcome which may address the situation to some extent,” Sehgal said, adding that to address this, the draft rules should have provided some guidance on the same to reduce the likelihood of litigations.
He also noted that it is surprising that for the purpose of allotments to residents, why these alternative methods cannot be used to justify the valuation, where in practice, these valuation methods are generally and could have been used.
Bhavin Shah, deals leader, PwC India, noted that almost all fresh investments by venture capital funds in startups has historically been through CCPS. “The relaxation provided under draft rules for price matching and 10% safe harbour is restricted to equity shares. It is important that these relaxations are extended to investments by way of CCPS as well,” he said.
Further, for price matching, the draft rules provide for separate baskets for venture capital funds and offshore notified entities. “The government may consider combining both these under a single basket if they invest in the same round,” he said.
Another expert noted that the safe harbour of 10% could possibly be kept slightly higher at 20% or so.
The Union Budget had amended Section 56(2) viib of the Income Tax Act that would bring foreign investors under the angel tax regime. Effective April 1, unlisted companies issuing shares at a premium to non-residents in excess of FMV will also be taxed.
The CBDT had recently also notified a list of 21 countries of which specified entities would not be subject to angel tax in India. Investors including government and government-related investors such as central banks, sovereign wealth funds, international or multilateral organisations controlled by the government or where the government ownership is over 75% as well as banks or entities involved in insurance when it is subject to applicable regulations in the country of its residency or incorporation would be exempt from the tax as well as DPIIT registered start-ups.
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