The Finance Ministry has issued the final rules pertaining to the valuation of the shares issued by unlisted startups to resident and non-resident investors under the new angel tax mechanism introduced in the Finance Act, 2023.
The Central Board of Direct Taxes (CBDT) stated that the valuation of compulsorily convertible preference shares (CCPS) can also be decided on the fair market value (FMV) of unquoted equity shares. As per the announcement of the Income Tax Department, all five valuation methodologies that were included in the draft rules have been retained.
Welcoming the changes, Manick Wadhwa, Director of Strategy at SKI Capital Service Ltd, said that the new mechanism offers greater flexibility in valuation methods.
“The amendment to Rule 11UA expands the valuation methods for startups beyond the original Adjusted Net Asset Value (NAV) and Discounted Cash Flow (DCF). New methods comprise Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, and Replacement Cost Method. These additional options, especially pertinent for non-resident investors, offer greater flexibility in valuation. Moreover, a 'ninety-day clause' is introduced, stating that valuation reports by SEBI-registered Merchant Bankers are valid if prepared within 90 days of the share issue date, Wadhwa said.
With the amendment, the ambit of angel tax has now widened and included foreign investments, whereas previously, it was only applicable to local investors.
Introduced in 2012 as a measure to combat tax evasion and illicit financial activities, the angel tax necessitates that unlisted startups pay a tax, typically around 30 per cent, on investments they receive through the issuance of shares to investors at prices exceeding the fair market value (FMV) of those shares. This excess amount is treated as income for the startup.
Initially, the angel tax applied solely to investments from Indian residents, but as of the Finance Act 2023, it has been extended to encompass non-resident investors. Since 2019, startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT) have been exempted from the angel tax.
Key Changes In Rule 11 UA
Along with the two existing methods for valuation of shares—Discounted Cash Flow (DCF) and Net Asset Value (NAV) method—available to resident investors, 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, and Replacement Cost Method.
In cases where a startup acquires investment by issuing shares to a non-resident entity specified by the Central Government, the equity share price associated with this investment can be considered the fair market value (FMV) for both resident and non-resident investors, with the following conditions:
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.
Valuation methods for calculating the FMV of Compulsorily Convertible Preference Shares (CCPS) have been provided.
A safe harbor of 10 per cent variation in value has also been provided.
