Notification of amendment to Rule 11UA of Income Tax Rules for valuing investments in startups

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Notification of amendment to Rule 11UA of Income Tax Rules for valuing investments in startups

Tejasvi

@tejasvi

September 28, 2023

Public Policy

Ministry of Finance (MoF) has issued Notification No. G.S.R 685(E) dated September 25, 2023 (Notification) to amend Rule 11UA of Income Tax Rules, 1962 (IT Rules) which prescribes the methodology for valuation of shares for applicability of S.56(2)(viib) of the Income Tax Act. 1961 (IT Act) [commonly referred to as Angel Tax].

To recap, Budget 2023 introduced an amendment as per which investments received from non-residents investors (in addition to the investments from resident investors) above Fair Market Value (FMV) for issue of shares by an unlisted company will be taxed. Pursuant to this, MoF released a consultation paper in May 2023 suggesting amendments to Rule 11UA of IT rules. Nasscom’s response to the consultation paper can be accessed from here.

Summary of changes notified:

The amended rules are applicable from the date of publication of the notification in the Official Gazette (i.e., from September 25, 2023).

Where consideration is received by an unlisted company for issue of unquoted equity shares from Venture Capital (VC) fund, specified fund or notified entity, the price of such equity shares may be taken as FMV subject to the following:

To the extent that the consideration from such FMV does not exceed the aggregate consideration that is received from VC fund, specified fund or notified entity.
The consideration has been received from VC fund, specified fund or notified entity within 90 days before or after the date of issue of shares which are the subject matter of valuation.

Inclusion of following 5 new valuation methodology for valuation of shares granted to non-resident investors in addition to Discounted Cash Flow (DCF) and Net Assets Value (NAV) method:

Comparable Company Multiple Method
Probability Weighted Expected Return Method;
Option Pricing Method;
Milestone Analysis Method; and
Replacement Cost Method.

Valuation methods for calculating the FMV of Compulsorily Convertible Preference Shares (CCPS) have also been provided with respect to investments made by residents as well as non-residents.

Valuation report given by Merchant Banker will be acceptable, if it is of a date not more than 90 days prior to the date of issue of shares which are subject matter of valuation. This amendment is in line with nasscom’s recommendation that the 90-day time limit for the merchant banker report should be applicable to issue of CCPS as well.

The amended rules allow for 10% safe harbour in case of issue of unquoted equity shares and CCPS to account for forex fluctuations, bidding processes and variations in other economic indicators, etc. This amendment is in line with nasscom’s recommendation that the 10% safe harbour should be applicable to issue of CCPS as well.

Missed Opportunity:

One of the main challenges with the administration of angel tax is the fact that tax officer repudiates the valuation report by comparing the projections in the valuation report against actual performance. Any deviation (beyond 10%) is likely to results in the valuation report being rejected. To address this, government should develop a Standard Operating Procedures (SOPs) in consultation with stakeholders, that could be followed by tax officers in case there are deviations in projections.
The amended Rule 11UA is applicable from September 25, 2023 whereas the amendment to angel tax provisions is applicable from April 1, 2023. Investments received by Indian private companies/ start-ups between April 1, 2023 and the date of implementation of amended Rule 11UA (i.e, September 25) may not be eligible for beneficial provisions like 5 additional methods for valuation of equity shares to non-resident investors, grace period of 90 days available in respect of valuation report, safe harbour of 10% with respect to consideration received in excess of FMV.
The 5 new methods of valuation notified under Rule 11UA are applicable only for valuation of shares issued to non-residents. For resident investors, NAV and DCF method continues to be the only prescribed valuation methods. This could bring in complexities in valuation as different methods will need to be followed where resident and non-resident investors are participating in the same round of investment.

We hope you will find the update useful. Please reach out at Tejasvi@nasscom.in and Garima@nasscom.in in case you have any feedback/ concern.

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Tejasvi