Investments in start-ups: IT Department proposes 5 valuation methods

The Income Tax Department on Friday proposed five new valuation methods for calculating Angel Tax under a new mechanism for non-resident investors in startups. The department has already said that regulated investor entities from 21 countries/jurisdictions and recognised startups will get immunity from the new mechanism.

The new mechanism will come into effect on April 1, 2024. Stakeholders can give their comments on the draft by June

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According to the draft, new valuation methods include Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method and Replacement Cost Method. These will be apart from existing two methods -- Discounted Cash Flow (DCF) and Net Asset Value (NAV). The department has already said that valuation report by the Merchant Banker would be acceptable.

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It has also been proposed that the valuation report by the merchant banker for the purpose of this rule would be acceptable, if it is of a date not more than 90 days prior to the date of issue of shares, which are subject matter of valuation.

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

The draft also proposed that in case of consideration received by a startup from resident as well as non-resident investor, the fair market value for unquoted shares will be derived on a formula, which is (A- L)x [PV/PE].

Here, A is book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income Tax Act and any amount shown in the balance-sheet as asset including the un-amortised amount of deferred expenditure which does not represent the value of any asset L refers to book value of liabilities shown in the balance-sheet. PE means total amount of paid-up equity share capital and PV is paid up value of such equity shares.

On Wednesday, the government issued two notifications prescribing list of entities from specified countries for exemption. These entities include government and government-related investors such as central banks, sovereign wealth funds, international or multilateral organisations or agencies including entities controlled by the government with 75 per cent equity or more. Apart from these banks or insurance companies, entities registered with the Securities and Exchange Board of India as Category-I foreign portfolio investors, endowment funds associated with a university, hospital or charity and pension funds will get exemption.

Another category of exempted entities is broad-based pooled investment vehicles or a fund where the number of investors are more than 50 and such fund is not a hedge fund or afund that employs diverse or complex trading strategies.

The exempt entities need to be incorporated in any of the 21 specified countries - Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US.

By another notification, the Ministry modified the 2019 notification mechanism to facilitate exemption to DPIIT (Department For Promotion of Investment and Internal Trade)-recognised start-ups from the new angel tax provision.

Commenting on draft, Amit Agrawal, Partner with Nangia Anderson said, “These amendments are likely to instill a sense of confidence among foreign investors, reassuring them of India’s commitment to creating an investor-friendly ecosystem. The harmonisation of valuation rules with internationally accepted methods of valuation denote alignment of India’s tax valuation rules with global best practices in taxation and regulatory frameworks.

“The new valuation methods are likely to bridge the gap between the valuation rules outlined in the FEMA regulations and the Income Tax Rules. Implementing consistent valuation norms can enhance transparency and reduce ambiguity, ultimately facilitating smoother cross-border transactions,” he said.

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