The Finance Ministry has notified final rules outlining valuation methods for non-resident and resident investors under the new angel tax mechanism in the Finance Act 2023. Besides the rules mentioned in the draft issued in May, the notification has introduced an additional sub-clause addressing Compulsorily Convertible Preference Shares (CCPS).

Angel tax (income tax at the rate of 30.6 per cent) is levied when an unlisted company issues shares to an investor at a price higher than its fair market value (FMV). Earlier, it was imposed only on investments made by a resident investor. But Budget 2023-24 proposed to extend angel tax even to non-resident investors from April 1, 2024.

Besides the discounted cash flow (DCF) method for resident investors, the new rule prescribes five methods for non-resident investors - comparable company multiple method, probability weighted expected return method, option pricing method, milestone analysis method and replacement cost methods.

Fair market value

When a company receives any consideration for the issue of shares from a non-resident entity notified by the Centre, the price of the equity shares corresponding to such consideration may be taken as the (FMV of the equity shares for resident and non-resident investors.

On similar lines, price matching for resident and non-resident investors will be available with reference to investment by venture capital funds or specified funds. It has been proposed that the valuation report by the merchant banker for this rule will be acceptable if it is of a date not more than 90 days prior to the date of issue of shares, which are the subject matter of valuation.

‘Safe harbour’ provision

Further, to account for forex fluctuations, bidding processes and variations in other economic indicators, which may affect the valuation of the unquoted equity shares during multiple rounds of investment, rule has prescribed provision of a safe harbour of 10 per cent variation in value.

According to the notification, the valuation of CCPS can also be based on the fair market value of unquoted equity shares. It has been provided that where the date of merchant banker’s valuation report is not more than 90 prior to the date of issue of shares under valuation then such date can be deemed be the valuation date if the assessee so chooses.

CCPS valuation mechanism

Commenting on the notification, Amit Maheshwari, Tax Partner with tax ad consulting firm AKM Global, felt that new rules have taken care of an important aspect of CCPS valuation mechanism which is a major investment route for VC funds into India. “The extension of 10 per cent safe harbour provision to CCPS investments, which was earlier meant for equity shares, will give necessary margin of safety for taking care of foreign exchange fluctuations,” he said.

Gaurav VK Singhvi, Co-Founder of We Founder Circle, said the 10 per cent safe harbor benefit to investments made in convertible preference shares means that startups can raise funds through both equity and convertible preference shares up to a certain limit (10 per cent of the FMV of their shares), and these investments will not be subject to angel tax as long as they meet the criteria outlined in the safe harbor provision. “It provides relief to start-ups and investors by reducing the tax burden and simplifying the taxation of such investments,” he said.