[Opinion] New Valuation Method Under Rule 11UA

CA Rakesh Kedia & Saloni Jain – [2023] 157 taxmann.com 409 (Article)

The concept of “Angel Tax”, first introduced by the Finance Act of 2012, has now been around for more than a decade. The intention behind the enactment of section 56(2)(viib) of the Income Tax Act, 1961 was to deter the creation of shell firms and to prevent the circulation of black money through the subscription of shares of closely held companies at unreasonable high valuation.

In the company, share capital is the capital receipt, not liable for tax. However, if revenue receipt, in the grab of share capital, is introduced in the company that needs to be taxed.. This section treats any excess over market value as liable to tax, treating it akin to a revenue transaction.

Angel tax provision (56(2)(viib)) were applicable on assesses , not being a company in which the public are substantially interested, receiving the consideration on the issue of shares that exceeds the face value of such shares. The aggregate consideration received for such shares as exceeds the fair market value of the shares so issued is subject to tax.

For Example:-ABC Pvt. Ltd issued the shares whose Face value Rs.10. If FMV of the issued share was Rs. 100 and such shares were issued at RS. 200 per share then Rs.100 {Rs.200-Rs.100) will be taxed under section 56(2)(viib) of Income Tax Act, 1961 in the hand of ABC Pvt. Ltd , issuing such shares.

Under the provision to the section, the following investment is excluded from the ambit of angel tax provision.

1. Investment received by a venture capital undertaking from a venture capital company or a venture capital fund or a specified fund; or
2. Investment received by a company from a class or classes of persons as may be notified by the Central Government.

How do you determine the FMV of the issued share?

As per section 56(2)(viib), FMV will be determined as under –

1. Valuation of issued share as per rule 11UA
2. substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature,

“whichever is higher”.

Is there a loophole in section 56(2)(viib) as it is not applicable to a Non-Resident person?

Yes, up to 31.03.2023 Section 56(2)(viib) was applicable only to resident individuals. To plug such loop hole, section 56(2)(viib) was amended, vide Finance Act, 2023 w.e.f 1.04.2024, whereby, it is applicable even to the share issued to non – resident person on or after 01.04.2023 i.e. during previous year 2023-24, relevant to assessment year 2024-25. This is one of the major reason for CBDT to bring in amendment in Rule 11UA(2).

Indian companies over the past decade have been witness to huge inflow of funds from investor, based outside the India, in the form of Foreign Direct Investment. Section 56(2)(viib) was only applicable on share issued to “Resident” person. “Non- Resident person” was out of its preview, as if any shares was issued to any non-resident person even at the higher value than the FMV of such issued share then such differential amount was not taxed in the hand of the investee company.

What is Rule11UA??

Rule 11UA of the Income Tax prescribes the valuation methodology for determining the FMV of various types of assets (including unquoted equity shares), not only for the purposes of the angel tax provision but also for other anti-abuse provisions involving transfer of assets without consideration or at a value less than the FMV. Assesses can choose any method for valuation of share as per rule 11UA(2).

Can you explain it more???

Rule11UA(2) prescribes the method of valuation specially for the issue of shares as per section 56(2)(viib). Earlier, there were only two methods prescribed for the purpose of valuation i.e. NAVM (Net Asset Valued Method) and Discounted Free Cash Flow Method. Since, section 56(2)(viib) was only applicable on the issue of share to resident, such method of valuation was only applicable on the share issued to residents.

However, in the amended Rule11UA (2) w.e.f. 01.04.2024 after covering the non-resident also, the number of method for the purpose of valuation of issue shares (to non-residents) has increased, including some international methods also.

Click Here To Read The Full Article