Overview
The Finance Act, 2023 significantly expanded the scope of India’s angel tax provisions under Section 56(2)(viib) of the Income-tax Act by extending its applicability to investments received from non-resident investors in unlisted companies. While the amendment aimed to curb circulation of unaccounted money through inflated share premiums, it triggered widespread concern among startups, venture capital ecosystems, and closely held companies due to valuation complexities and regulatory uncertainty.
In response to industry concerns, the CBDT introduced multiple relief measures through amendments to Rule 11UA, exemptions for specified foreign investors and DPIIT-recognized startups, and eventually notified the final valuation framework via Notification No. 81/2023 dated 25 September 2023. The revised regime introduced a 10% safe harbour, additional internationally accepted valuation methodologies for non-resident investments, price matching provisions, flexibility in merchant banker valuation reports, and specific valuation mechanisms for CCPS.
The amendments attempt to strike a balance between anti-abuse safeguards and India’s broader objective of promoting startup funding and foreign investment. However, practical issues relating to scrutiny by Assessing Officers and interpretation of valuation methods continue to remain areas of litigation and debate.
The Finance Act, 2023, brought in an amendment to bring the consideration received from non-residents for issue of shares by an unlisted company within the ambit of section 56(2)(viib) of the Income-tax Act, which provides that if such consideration for issue of shares exceeds the Fair Market Value (FMV) of the shares, it shall be chargeable to income-tax under the head ‘Income from other sources’. The logic behind application of this angel tax to NRIs had been cited as to prevent generation and circulation of unaccounted money through share premium received from NRI investors in a closely held company (CHC) in excess of its fair market value. However, it was considered difficult to convince field officers about the valuation of start-ups or even new enterprises with good business prospects. This could have an impact on the growth of start-ups and new enterprises in India, which would have gone against the Government’s broad focus. The CBDT thus announced certain amendments to valuation rules (i.e., Rule 11UA) vide Press Release dated 19 May 2023 and issued draft of amended Rule 11UA for public comments on 26 May 2023.
Further, vide Notification No. 29/2023 dated 24th May, three categories of entities were notified to have been retrospectively exempted from Sec 56(viib) since 1st April 2023. These were those entities which were registered with Sebi as Category-I FPI, Endowment Funds, Pension Funds and broad-based pooled investment vehicles, which are residents of 21 specified nations, including the US, UK, Australia, Germany and Spain. Important is that top jurisdictions like Singapore, Mauritius and UAE are excluded from the specified nations list - these three countries together constitute over 50% FDI in India. Furthermore, Notification No. 30/2023 exempted start-ups companies from the angel tax provision if the start-up company fulfils the conditions specified by DPIIT in para 4 of its Notification No. G.S.R 127(E) dated 19 February 2019 and files a self-declaration to that effect. The exemption was applicable where a start-up company issue shares for a consideration at a premium to any person (whether resident or non-resident). The said Notification came into force retrospectively from 1 April 2023. It superseded the earlier CBDT Notification No. 13/2019 which granted similar exemption to start-ups for issue of shares to resident investors.
With already so much water under the bridge, now the CBDT has notified the final amended Rule 11UA vide Notification No. 81/2023 dated 25th September, 2023. The salient features of the amended Rule 11UA are as under:
● The most important aspect is that the amended Rule 11UA introduces safe harbor limit of 10% for valuation of equity shares and compulsorily convertible preference shares (CCPS) for both resident and NR investments. This will reduce the burden of Angel Tax on startups and other CHCs that receive investments from angel investors and venture capitalists.
● The amended Rule 11UA provides separate valuation mechanism for CCPS and also provides an option to adopt fair market value (FMV) of unquoted equity shares for determining FMV of CCPS.
● The erstwhile Rule 11UA prescribed two methods (viz. NAV or DCF) for determining the FMV of equity shares issued to resident investors. The amended Rule 11UA provides five new methods of valuation for issue of unquoted equity shares or CCPS to NR investors viz. Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method and Replacement Cost Methods. These methods are exclusively applicable for determining the FMV of shares issued to nonresident investors.
● However, on the field new questions arise. Thus a question arose as to whether in case the assessee opts for determination of the fair market value of the shares by opting for any of the methods prescribed under rules, then can the AO reject that method itself?
Or should the AO only limit himself to scrutinizing the valuation report within the conditions or parameters laid down in the method chosen by the assessee? This was answered in the case of Innoviti Payment Solutions Pvt. Ltd. Vs. ITO reported in (2019)
102 taxmann.com 59 (Bangalore Trib) wherein the co-ordinate Bench of the Tribunal held that the method adopted by the assessee has to be accepted by the AO. The AO can ofcourse point out any defect in the implementation of the valuation method. The same was also held in the case of THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 16(1), HYDERABAD Vs M/s NCL GREEN HABITATS PRIVATE LIMITED [2023-VIL-717-ITAT-HYD].
● The price matching facility, for equity and CCPS, provides that the price at which unquoted equity shares or CCPS are issued by CHC to notified NR entities/ venture capital funds (VCF)/ specified funds shall be adopted as FMV for the purposes of benchmarking equity and CCPS investments by both resident and NR investors, subject to compliance of certain conditions. However, the CHC must receive consideration from the notified entity within 90 days before or after issuing the shares in question.
● The erstwhile Rule 11UA required merchant banker DCF valuation report as on the date of issue of shares. Now the valuation report by the Merchant Banker would be acceptable if it is of a date not more than 90 days prior to the date of issue of shares
● The rules are applicable to all cases of issue of unquoted equity shares on or after September 25, 2023.
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