Angel tax regime: Draft rules give investors more valuation flexibility

The rules released for public feedback offer investors the choice of five valuation methods for determining angel tax incidence under Section 56(2)(vii)(b) of the Income Tax Act 1961, which should help reduce valuation disputes common under the cash flow method and net asset value method allowed earlier.

Tax experts, however, said the proposed norms mention only equity shares, leaving out instruments such as compulsorily convertible preference shares (CCPS) used extensively to inject capital into startups. The draft rules provide startup investors a safe harbour of 10% variation from the determined value.

ETtech

This 10% variation clause makes concessions for forex fluctuations, bidding processes and variations in other economic indicators. The rules were issued by the Central Board of Direct Taxes (CBDT).

Besides the discounted cash flow method and net asset value method already in use, the draft rules allow a merchant banker to use any of the five methods — comparable company multiple method, probability-weighted expected return method, option pricing method, milestone analysis method and replacement cost methods — for determining fair market value.

Additionally, a venture capital undertaking can issue shares to a venture capital fund or a venture capital company or a specified fund at the same price at which it issued shares to another such entity within ninety days of the investment.

Discover the stories of your interest

Such a price will be considered fair market value but the total consideration in this second investment cannot exceed the initial investment. For example, if a venture capital undertaking receives a consideration of Rs 50,000 from a venture capital company for 100 shares at the rate of Rs 500 per share, then such an undertaking can issue 100 shares at this rate to any other investor within a period of 90 days of the receipt of consideration from the venture capital company. The CBDT will issue the final rules after looking into public comments.The board has already exempted investments by non-resident investors including central banks, multilateral entities, foreign pension and endowment funds, banks and insurers, and foreign portfolio investors from 21 countries from the angel tax.

“Concept of price matching, 10% safe harbour in valuation and five new methods of valuation are all very welcome,” said Bhavin Shah, partner and deals leader, PwC.