In most cases, fundraising becomes more of a necessity than a choice if you wish to build, grow or expand your operations as a startup. However, valuation becomes an important parameter to consider as the shares of these companies are not listed and the valuation at which the funds are raised is dependent upon the future potential of the business. The Income Tax Department has notified the new angel tax rules that indicate the mechanism for determining the value of shares issued by the startups to investors.
New Angel Tax Rules for Investors & Startups
The Finance Act, 2023 brought in the provisions whereby if an unlisted company issues shares to non-resident investors, then it shall fall within the ambit of Section 56(2)(viib). Accordingly, if the consideration of such shares exceeds the Fair Market Value (FMV) of these shares, then such excess shall be chargeable under the head ‘Income From Other Sources’.
Key Changes Under the Rule 11UA of the Income Tax Rules, 1962
- Method of Valuation: Rule 11UA prescribed two methods of valuation i.e., the Discounted Cash Flow (DCF) method and Net Asset Value (NAV) method. Now, 5 new valuation methods under Rule 11UA have been prescribed for non-resident investors. These include:
- Comparable Company Multiple Method
- Replacement Cost Method
- Probability Weighted Expected Return Method
- Replacement Cost Method
- Option Pricing Method
- Milestone Analysis Method
- FMV as the Price: In case consideration against the issue of equity shares is received from any non-resident investor notified by the Central Government, then the price of such equity shares may be taken as FMV of the equity shares subject to the following conditions:
- To the extent that the consideration from such FMV does not exceed the aggregate consideration received from the notified entity
- The consideration from the notified entity is received within 90 days before or after the date of issue of equity shares that are subject to valuation.
Price matching for resident and non-resident investors should be available with reference to investments by the Specified Funds or Venture Capital Funds. Further, valuation methods for determining the FMV of the Compulsorily Convertible Preference Shares (CCPS) have also been provided for.
- Safe Harbour Rules: The government has also introduced safe harbour rules for angel tax in order to account for the factors that may affect the valuation of unquoted shares during multiple rounds of investments. These indicators include bidding processes, variations in economic indicators and forex fluctuations. The safe harbour of 10% variation in value has been decided for and the same has also been extended for the CCPS. This will allow the entrepreneurs and investors to raise funds through both equity and convertible preference shares up to a certain limit. These investments will not be subject to angel tax as they meet the criteria of safe harbour rules.
For more information and clarification relating to the new angel tax norms and their implications for your startup and investment, reach out to ASC Group.
Also, Read- Section 269SS of Income Tax Act, 1961