Hello Readers,
As you may be aware, the Finance Act 2012 had introduced provision of section 56(2(viib) of the Income Tax Act, 1961. Via this newsletter, we bring to you the salient features of the recent changes to the scheme introduced.
To give a context, the provision of section 56(2)(viib) intended to tax consideration received by closely held companies from residents for issue of shares that exceeds the face value of share. The provision covered consideration exceeding the fair market value of shares. The provision was made applicable only to residents with specific carveout for consideration for shares issued by a venture capital undertaking from a venture capital company, venture capital fund, specified fund or class of persons as notified. The provision was introduced as an anti-abuse measure to prevent circulation of unaccounted domestic money through share sale-purchase transactions. The Finance Act, 2023 has however extended the applicability of the provision to all categories of person, thereby bringing within the purview issuance of shares to non-resident.
Considering wide impact of the amendment, the government has by way of Notification No. 29/2023 dated 24 May 2023 excluded investment made by the following categories of foreign investors from applicability of the provisions:
- Government and Government related investors, international or multilateral organizations and entities controlled by the Government or where direct or indirect government ownership is seventy-five percent or more;
- Banks or Entities involved in Insurance Business;
- Entities resident of 21 specified jurisdictions which are registered with SEBI as Category-I Foreign Portfolio Investors; endowment funds associated with a university, hospitals or charities; pension funds; Broad Based Pooled Investment Vehicle or fund where the number of investors is more than fifty (other than hedge fund or a fund which employs diverse or complex trading strategies). The specified jurisdictions notably exclude Singapore and Mauritius.
Further, as a result of the above amendment, representations were received from various stakeholders raising concerns that genuine non-resident investors may have to face undue hardship in matters related to valuation of shares etc. To address the concerns, the government has on 26 May 2023 issued draft notification for public comments proposing changes to the valuation rules as prescribed under Rule 11UA of the Income Tax Rules on the aspect of determining the fair valuation of the shares to assuage the concerns of various stakeholders.
Rule 11UA of the Income Tax Rules currently prescribes valuation based discounted cash flow (DCF) or net asset value (NAV) method. As per the draft rules, in addition to NAV and DCF method, the following are proposed for recognition as fair valuation:
- where consideration is received by a venture capital undertaking for issue of shares, from a venture capital fund or a venture capital company or a specified fund, the price of the equity shares corresponding to such consideration will be regarded as the fair market value of the equity shares provided the consideration has been received within a period of ninety days of the date of issue of shares which are the subject matter of valuation.
- where any consideration is received by a company for issue of shares, from any notified entity, the price of the equity shares corresponding to such consideration will be regarded as the fair market value of the equity shares provided the consideration from notified entity has been received within a period of ninety days of the date of issue of shares which are the subject matter of valuation.
- Further in relation to consideration received from a non-resident, the fair market value of the unquoted equity shares can be additionally determined by a merchant banker in accordance with any of the following methods:
- Comparable Company Multiple Method;
- Probability Weighted Expected Return Method;
- Option Pricing Method;
- Milestone Analysis Method;
- Replacement Cost Methods.
The proposed Rules further provide a safe harbor of 10 percent to accommodate variation between issue price and fair valuation determined as per prescribed valuation methods.
We will keep you updated as and when any further changes occur in this space. Thank you for your time. Till we meet again.
Best regards,
Research Desk at Aureus Law Partners
Should you have any queries, please feel free to reach out to our Practice Leader – Tax at yatin.sharma@aureuslaw.com.