The government on Friday announced proposed changes to the tax regulations pertaining to angel investors. The tax department released a statement outlining its plan to expand the valuation methods used for calculating investment value and revising the tax requirements for angel investors.

The phrase ‘angel tax’ is essentially used to describe the tax that must be paid on the funds raised by unlisted companies through the issuance of shares in off-market transactions, if they exceed the fair market value of the company.

The Central Board of Direct Taxes (CBDT) proposed amendments to Rule 11UA regarding the valuation of shares for the purpose of section 56(2)(viib) of the Income-tax Act, 1961. These changes aim to address concerns surrounding the applicability of Tax Collection at Source (TCS) on shares issued to non-residents.

Currently, Rule 11UA prescribes two valuation methods, namely Discounted Cash Flow (DCF) and Net Asset Value (NAV), for resident investors. The government intends to include five additional valuation methods specifically for non-resident investors, in addition to the existing DCF and NAV methods.

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Commenting on the amendment, Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen LLP, said, "The amendment was seen as an antithesis to India's ardour of being an investor-friendly jurisdiction, and several representations were made by the investor community to the Government due to the glaring incongruence between the valuation mechanism on the issue of shares as per FEMA rules and the Income Tax Rules. Where on one hand FEMA accepts any internationally accepted pricing methodology and sets the minimum or floor price for issue, on the other hand, the Income tax Rules cap the share price to the FMV (computed as per Discounted Cash Flow method or the Net Asset value method), and any price above the capped price is taxed."

"However, stakeholders were clutching the straws to ensure that spirits are not dampened and investments continue with minimal setbacks. In the midst of this uppity climate, the notification can be seen as an attempt to assuage frayed nerves of stakeholders by acknowledging the problem statement and seeking to bring respite by proposing to amend the valuation rules and notifying certain excluded entities. As a welcome move, the Government has proposed to introduce 5 new valuation rules to quell the FEMA vs tax battle. Merchant Banker valuation, however, seems mandatory now for all valuation methods, though with an extended validity of 90 days prior to share issue date, which was earlier aligned to the date of issue of shares itself and was a requisite only for DCF valuation."

The proposal to introduce a safe harbour of 10 percent to ringfence valuation of unquoted shares on account of forex fluctuations, bidding processes and variations in other economic indicators, etc is a welcome indication. Proposal to notify non-resident entities for angel tax immunity and broadening up of the list of excluded entity category to cover non-resident entities with 75 percent Government ownership, SEBI registered FPIs and broad based pooled investment vehicles, could also free up few more Indian startups from the rigor of angel tax," he added.

According to the statement, if a company receives consideration for issuing shares from a non-resident entity notified by the Central Government, the price of the equity shares corresponding to such consideration may be considered as the Fair Market Value (FMV) of the shares. However, this is subject to two conditions: first, the consideration from the FMV should not exceed the total consideration received from the notified entity, and second, the company must receive the consideration from the notified entity within ninety days from the date of issuing the shares that are being valued.

In the same line, price matching for resident and non-resident investors will be implemented for investments made by Venture Capital Funds or Specified Funds. Additionally, the government has put forth several key proposals to enhance the valuation process for unlisted equity shares.

Firstly, it is suggested that the valuation report prepared by a Merchant Banker will be considered acceptable if it is not older than ninety days from the date of issuing the shares being evaluated. This ensures the relevance and accuracy of the valuation.

Furthermore, to account for factors such as forex fluctuations, bidding processes, and variations in economic indicators, a safe harbor of 10 percent variation in value will be introduced. This provision aims to accommodate potential fluctuations in the value of unquoted equity shares during multiple rounds of investment.

The draft Rules encompassing these proposals will be made available for public comments for a period of ten days. After considering the feedback received, the finalised rules will be officially notified.

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First Published:May 19, 2023 10:29 PM IST