Current Requirements

FMV of shares is determined according to Rule 11UA(2) of the Income Tax Rules. This rule prescribes the use of the net asset method based on a specific formula or use of other International valuation methods supported by a Merchant Banker’s report.

To comply, private companies issuing shares have been required to obtain:

1. A valuation report from a Registered Valuer as per the Companies Act.
2. A valuation report from a Merchant Banker as per Income Tax Regulations.

Amendment made in Finance Act, 2024

Finance Act, 2024 proposes to eliminate the requirement under Section 56(2)(viib) with effect from 1^st April, 2025. Moving forward, the issuance of shares will no longer require a Merchant Banker’s valuation report. Instead, shares can be issued at any price based on the valuation report from a Registered Valuer alone.

Impact and Benefits

This amendment is set to streamline the share issuance process for Start ups by:

• Removing the dual valuation report requirement.
• Reducing compliance costs and administrative burden.
• Providing greater flexibility in pricing shares based on professional valuations.

Disclaimer

The information provided in this blog is for general informational purposes only and is not intended to be legal, tax, or professional advice. Readers should consult their own advisors for specific guidance on how these changes may impact their individual circumstances.

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Valuation Methods Prescribed in the New Rule :

The revised Rule 11UA introduces several valuation methods for determining the fair value of shares in the context of share issuance. These methods are as follows:

(A) Book Value Method: The formula for this method remains unchanged from its previous iteration.

(B) DCF Method: Under this method, the fair value is calculated using the Discounted Cash Flow (DCF) approach, with the valuation report obtained from a Merchant Banker.

(C) Venture Capital Case: Shares may be valued at the same price at which a Venture Capital Undertaking raised funds from a Venture Capital Fund or Venture Capital Company or an Alternative Investment Fund. A maximum gap of 90 days is permissible on either side between the shares subject to valuation and shares issued to such VC or AIF.

(D) Comparable Company Multiple, Probability-Weighted Expected Return, Option Pricing, Milestone Analysis, or Replacement Cost Method: The valuation under this method is conducted after obtaining report from a Merchant Banker.

(E) Notified Entity Case : Shares can be valued at the same price at which the company received funds from a notified entity. Similar to method (C), a maximum gap of 90 days is permitted between the shares subject to valuation and shares issued to such notified entity.

Equity Share Valuation

Issued to Resident : For shares issued to residents, the assessee can choose any one method from (A), (B), (C), or (E). Notably, option (D) is not available for share issuance to residents.

Issued to Non-Resident : In the case of shares issued to non-residents, the assessee has the flexibility to choose any method from (A) to (E).

Compulsory Convertible Preference Share Valuation

To Resident : For shares issued to residents, Valuation can be conducted using option (B), (C), (E), or by deriving valuation from equity share valuation undertaken as detailed above.

To Non-Resident : In the case of shares issued to non-residents, Shares can be valued using options (B) to (E) or by deriving valuation from equity share valuation as detailed above.

Timeframe Consideration

It is important to note that a maximum gap of 90 days is allowed between the date of the valuation report issued by the Merchant Banker and the date of share issuance.

Tolerance Threshold

There is also a tolerance threshold of 10%, which permits a gap in value between the valuation derived using the prescribed methods and the actual issue price. This tolerance applies to cases other than those utilizing methods (C) and (E)

It’s worth highlighting that these amendments pertain specifically to share issuance. No changes have been made for share transfers, and the existing rules continue to apply in those cases.

In conclusion, the recent amendments to Rule 11UA of the Income Tax Rules, 1962, bring about significant changes in the valuation of shares during issuance. Chartered Accountants should be well-versed in these updated methods and their applicability, ensuring compliance with the regulations and accurate valuation of shares.

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Proposed Changes in Rule 11UA:
Rule 11UA currently prescribes two valuation methods, namely the Discounted Cash Flow (DCF) and Net Asset Value (NAV) methods, for resident investors. In an effort to enhance fairness, the proposal aims to introduce five additional valuation methods applicable to non-resident investors, in addition to the DCF and NAV methods.

The proposed modification stipulates that if a company receives consideration for share issuance from a notified non-resident entity, the price of the equity shares may be considered as the FMV for both resident and non-resident investors. However, this applies only if consideration is received within ninety days from the date of share issuance.

Additionally, the proposal extends the provision of price matching to resident and non-resident investors for investments made by Venture Capital Funds or Specified Funds. To ensure reliability, a valuation report would be acceptable if it is no more than ninety days old from the date of share issuance.

Furthermore, considering the potential impact of forex fluctuations, bidding processes, and variations in economic indicators on the valuation of unquoted equity shares during multiple investment rounds, a safe harbor provision of 10% variation in value is proposed.

The draft Rules encompassing the above modifications will be made available for public comments for a period of 10 days, after which they will be formally notified.

Notification for Excluded Entities:
To address specific classes of non-resident investors, it is proposed to notify certain entities to whom clause (viib) of sub-section (2) of section 56 of the Act shall not be applicable. The exclusion includes:

(1) Government and Government-related investors: This category encompasses central banks, sovereign wealth funds, international or multilateral organizations or agencies controlled by the Government, or where the Government holds 75% or more direct or indirect ownership.
(2) Banks and Insurance entities: The exclusion applies to banks and entities involved in the insurance business, subject to applicable regulations in their respective country of establishment or incorporation or residency.
(3) Entities from certain countries or specified territories: The exclusion extends to entities registered with the Securities and Exchange Board of India as Category-I Foreign Portfolio Investors, endowment funds associated with universities, hospitals, or charities, pension funds created under foreign law, and broad-based pooled investment vehicles or funds with more than 50 investors that do not function as hedge funds or employ complex trading strategies.

Investment in recognized Startup:
The proposal also includes a modification to Notification No. S.O 1131(E) dated 5th March 2019, stating that the provisions of section 56(2)(viib) of the Act shall not apply to consideration received from Non-resident by start-ups covered in paragraphs 4 and 5 of the Notification dated 19th February 2019 issued by the Ministry of Commerce and Industry in the Department for Promotion of Industry and Internal Trade.

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