The Income Tax Department has introduced revised rules for valuing equity and compulsorily convertible preference shares (CCPS) issued by startups to both resident and non-resident investors. Effective from September 25, these changes are outlined in the amended Rule 11UA of the Indian Income Tax Act.
Under the new rules, the valuation of CCPS can now be based on the fair market value of unquoted equity shares. Additionally, the amended rules retain five proposed valuation methods for consideration received from non-resident investors, namely the Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, and Replacement Cost Method.
Amit Agarwal, a Partner at Nangia & Co LLP, noted that these amendments offer taxpayers greater flexibility through multiple valuation methods and simplify the valuation date consideration. They also aim to incentivize venture capital investments, facilitate investments from notified entities, provide clarity on CCPS, and encourage foreign investments. The inclusion of a tolerance threshold for minor valuation discrepancies enhances efficiency and fairness in tax assessments.
Amit Maheshwari, a Partner at AKM Global Tax, commended the inclusion of CCPS within the safe harbour provision of 10%, extending the benefit that was previously applicable only to equity shares. This extension provides a margin of safety to account for foreign exchange fluctuations, which is particularly significant for VC fund investments in India.
The Central Board of Direct Taxes (CBDT) had initially released draft rules in May for valuing funding in unlisted and unrecognised startups to levy income tax, often referred to as 'Angel Tax', and had sought public feedback. The revised rules aim to bridge the gap between the rules outlined in the Foreign Exchange Management Act (FEMA) and the Income Tax Act.
Previously, only investments made by domestic or resident investors in closely held or unlisted companies were taxed above the fair market value, a situation commonly known as angel tax. However, with the Finance Act of 2023, such investments exceeding the fair market value are now taxable, regardless of the investor's residency status. This change has led to concerns regarding the differing fair market value calculation methodologies specified in the two laws.