AMENDMENT TO RULE 11UA OF INCOME TAX RULES, 1962

  

DETERMINATION OF FAIR MARKET VALUE

NOTIFICATION NO. 81/2023 DATED SEPTEMBER 25, 2023

Background

◾                  Section 56(2)(viib) of the Income Tax Act, 1961 (“the Act”) provides that if a Company receives consideration for issue of shares, which exceeds the Fair Market Value (FMV) of such shares, then such excess differential consideration shall be chargeable to tax as ‘Income from Other Sources’ in hands of the Company

◾                  Accordingly, following are stipulations for applicability of Section 56(2)(viib) of the Act:

 

◾                   There should be issue of shares;

 

◾                   The shares should be issued at a premium;

 

◾                   The shares to be issued by a Company in which public are not substantially interest;

 

◾                   The consideration received by Company from issue of shares should be in excess of FMV of such shares.

 

◾                  Rule 11UA of Income Tax Rules, 1962 (“the Rules”) prescribes the manner for computation of FMV of the shares

 

Amendment in Budget 2023.

·       Prior to Finance Act, 2023, Section 56(2)(viib) provisions were applicable only when consideration for issue of shares was received by a Company from a ‘Resident’ person

 

·       The Finance Act, 2023 amended Section 56(2)(viib) to bring into its ambit consideration received by Company from ‘Non- Resident’ persons as well, in addition to ‘Resident’ person [amendment effective from 1 April 2024]

 

 

Notification No. 81/2023 dated September 25, 2023

 

◾                  Pursuant to Finance Act, 2023 amendment, Central Board of Direct Taxes (CBDT) vide Notification dated May 26, 2023 released the draft of amendments to Rule 11UA for public consultation

◾                  Now, CBDT vide Notification No. 81/2023 [GSR 685(E)] dated September 25, 2023 has released the Income-Tax (Twenty first Amendment), Rules 2023, thereby amending the provisions of Rule 11UA

 

The amended rules are effective from the date of the aforesaid Notification i.e. immediately.

 

 

 

Snapshot of Amendment.

 

 

 

 

 

Equity share value for resident investor.

 

◾                  Rule 11UA(2)(A)  The FMV of Unquoted Equity shares for purpose of Section 56(2)(viib) of the Act shall be the value as determined under sub-clauses (a), (b), (c) and (e), at the option of the taxpayer, as on valuation date, where consideration is received from a RESIDENT person

◾                  Sub-clauses (a) and (b) deal with valuation methods under generic circumstances i.e. without any stipulation on recipient or payer, being as under:

 

◾                   Sub-clause (a)  Adjusted Net Asset Value Method, basis the value of assets and liabilities in the balance sheet of the Company

[retained from erstwhile Rule 11UA] [Refer Annexure A]

 

◾                   Sub-clause (b)  Discounted Free Cash Flow Method, as determined by Merchant Banker [retained from erstwhile Rule 11UA]

◾                  Sub-clauses (c) and (e) deal with valuation methods for specific circumstances, as discussed below

 

◾                  Sub-clause (c)  Venture Capital Undertaking transaction value

 

◾                  Where consideration is received by Venture Capital Undertaking (VCU) from a Venture Capital Fund (VCF) or Venture Capital Company (VCC) or a Specified Fund (SF), the price of equity shares, at the option of VCU, may be taken as FMV of the equity shares to the extent it does not exceed the aggregate consideration that is received

◾                  The above FMV is acceptable if the consideration is received by the VCU from VCF/ VCC/ SF, within 90 days, either before or after, from the date of issue of shares which are subject matter of valuation

◾                  For instance, if VCU received INR 50,000 from VCC for issue of 100 equity shares at INR 500 per share on September 30, 2024, then such VCU can issue 100 shares at rate of INR 500 per share (as above) to any other investor within a period of 90 days before or after receipt of such consideration amount from the VCC i.e. in duration of July 2, 2024 to December 30, 2024

◾                   Definition of ‘Venture Capital Undertaking’, ‘Venture Capital Fund’, ‘Venture Capital Company’ and ‘Specified Fund’ to be adopted from Explanation to Section 56(2)(viib) of the Act [Refer Annexure B]

◾                  Sub-clauses (c) and (e) deal with valuation methods for specific circumstances, as discussed below

 

◾                  Sub-clause (e)  Notified entity transaction value

 

◾                  Where consideration is received by Company from any entity notified under clause (ii) of First proviso to Section 56(2)(viib) (Notified Entity), the price of equity shares, at the option of Company, may be taken as FMV of the equity shares to the extent it does not exceed the aggregate consideration that is received from Notified Entity

◾                  The above FMV is acceptable if the consideration is received by the Company from the Notified Entity, within 90 days, either before or after, from the date of issue of shares which are subject matter of valuation

◾                   The list of entities notified under clause (ii) of First proviso to section 56(2)(viib) is available at following link – Notified Entities

 

◾                  It may be noted that sub-clauses (c) and (e) are parallel in operation

Equity share value for non-resident investor.

◾                  Rule 11UA(2)(A)  The FMV of Unquoted Equity shares for purpose of Section 56(2)(viib) of the Act shall be the value as determined under sub-clauses (a), (b), (c), (d) and (e), at the option of the taxpayer, as on valuation date, where the consideration is received from a NON-RESIDENT person

◾                  Accordingly, where consideration is received from a Non-Resident person, apart from the methods and circumstances discussed in previous slides under sub-clauses (a), (b), (c) and (e) relating to receipt of consideration from Resident person, an additional method as per sub-clause (d) is also available

◾                  Sub-clause (d)  Other Methods

 

◾                   The FMV as determined by the 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

◾                  It may be noted that the Rules neither define any of the ‘Other Methods’ nor provide any guidance or reference towards

adopting the same

 

◾                  Accordingly, in absence of specific guidelines, principles of interpretation may suggest to adopt the meaning of the

methods from generally acceptable parlance, as applied universally

 

◾                  Interestingly, Institute of Chartered Accountants of India (ICAI) Valuation Standards (2018) provide guidance on following methods:

◾               Comparable Company Multiple Method

◾               Option Pricing Method

◾               Replacement Cost Methods

◾                  The International Private Equity and Venture Capital Valuation Guidelines (December 2018) provide certain guidance

on ‘Milestone Analysis Method’

 

 

 

 

 

 

 

 

 

 

 

Snapshot of Preference share value provision.

 

 

Resident Investor

 

◾                 Rule 11UA(2)(B)(i)  The FMV of Compulsorily Convertible Preference Shares (CCPS) for purpose of Section 56(2)(viib) of the Act shall be the value as determined according to sub-clauses (b), (c), and (e) of Rule 2(A) at the option of the taxpayer, as on valuation date OR based on FMV of unquoted equity shares determined under Rule 2(A), at option of taxpayer

◾                 Accordingly, where consideration is received from a RESIDENT, the FMV of CCPS, at the option of taxpayer, can be:

 

◾                 Based on value of CCPS determined as per Discounted Free Cashflow Method [sub-clause (b)], VCU transaction value [sub-clause (c)] or Notified entity transaction value [ sub-clause (e)]; OR

◾                 Based on FMV of unquoted equity shares of taxpayer determined as per Rule 11UA(2)(A) of Rules [discussed in previous slides]

 

Non-Resident Investor

 

◾                 Rule 11UA(2)(B)(ii)  The FMV of Compulsorily Convertible Preference Shares (CCPS) for purpose of Section 56(2)(viib) of the Act shall be the value as determined according to sub-clauses (b), (c), (d) and (e) of Rule 2(A) at the option of the taxpayer, as on valuation date OR based on FMV of unquoted equity shares determined under Rule 2(A), at option of taxpayer

◾                 Accordingly, where the consideration is received from a NON-RESIDENT, the FMV of CCPS, at the option of taxpayer, can be:

◾                 Based on value of CCPS determined as per Discounted Free Cashflow Method [sub-clause (b)], VCU transaction value [sub-clause (c)], Other Methods [sub-clause (d)], or Notified entity transaction value [ sub-clause (e)]; OR

◾                 Based on FMV of unquoted equity shares of taxpayer determined as per Rule 11UA(2)(A) of Rules [discussed in previous slides]

 

Deemed valuation date

 

◾                 The FMV of the shares for purpose of Section 56(2)(viib) is to be determined as at the ‘valuation date’

◾                 For purpose of Rule 11UA, the ‘valuation date’ is defined under Rule 11U(j) of the Rules as under:

 

"valuation date" means the date on which the property or consideration, as the case may be, is received by the assessee.

◾                 The newly inserted Rule 11UA(3) provides that if the date of merchant banker’s valuation report, as required under Rule 11UA(2), is not more than 90 days prior to the date of issue of shares under valuation, then at the option of the taxpayer, such date shall be deemed to be the valuation date

◾                 If the taxpayer adopts the option provided under Rule 11UA(3), the provisions of Rule 11U(j) are not applicable

◾                 It may be noted that the provisions of deemed valuation date are applicable only for valuation reports issued under Rule 11UA(2) and not under rule 11UA(1) of the Rules

 

Safe harbour rule

 

◾                  Under Section 56(2)(viib) read with erstwhile Rule 11UA, if the consideration received for the shares exceeded the FMV of

such shares as determined under Rule 11UA, then the entire excess consideration was chargeable to tax

◾                  The newly inserted Rule 11UA(4) provides some respite in form of safe harbour rules towards consideration received upon issue of Unquoted Equity shares or CCPS

◾                  Where consideration is received from a RESIDENT

 

◾                 As per Rule 11UA(4)(i)  if the issue price of shares exceeds the FMV determined according to the Adjusted Net Asset Value Method [Rule 11UA(2)(A)(a)] or Discounted Free Cashflow Method [Rule 11UA(2)(A)(b)] by 10% of such FMV determined, then such issue price shall be deemed to be FMV of shares for purpose of Section 56(2)(viib)

◾                  Where consideration is received from a NON-RESIDENT

 

◾                 As per Rule 11UA(4)(ii)  if the issue price of shares exceeds the FMV determined according to the Adjusted Net Asset Value Method [Rule 11UA(2)(A)(a)] or Discounted Free Cashflow Method [Rule 11UA(2)(A)(b)] or Other Methods [Rule 11UA(2)(A)(d)] by 10% of such FMV determined, then such issue price shall be deemed to be FMV of shares for purpose of Section 56(2)(viib)

◾                 Issue price is defined to mean consideration received by Company (taxpayer) for one share