The Union Budget 2023 expanded applicability of Section 56(2)(viib) of the Income-tax Act, 1961 (the Act), commonly referred to as angel tax provisions, regarding the issuance of shares by unlisted companies to non-resident investors. Thus, the provisions of Section 56(2)(viib) of the Act have been widened to cover within its ambit receipt of consideration from any person irrespective of their residential status. The objective was to widen the tax base by rationalizing the tax provisions and eliminating tax avoidance by non-residents.
As anticipated, there has been a lot of discussion doing rounds on the adverse impact this change would have on the flow of Foreign Direct Investments (FDIs) in India, the start-up eco-system and the investment fraternity in general. It was expected that the government would relax the applicability of stringent provisions of Section 56(2)(viib), which would help the companies, especially the start-ups, deal with the reduced capital inflows situation termed as ‘funding winter.'
In line with the expectation, the Central Board of Direct Taxes (CBDT), by Press Release, has proposed several changes to Rule 11UA, which provides for mechanisms to work out the valuation. The draft Rules on these lines will be shared for public comments for 10 days, after which it shall be notified.
A – Five more methods of valuation
The Act prescribes that the valuation of shares for the purpose of Section 56(2)(viib) shall be the value:
- As may be determined in accordance with Rule 11UA of the Rules (which provides an option of either Net Asset Value (NAV) method or Discounted Cash Flow (DCF) valuation (by Category I Merchant Banker) or
- As may be substantiated by the company to the satisfaction of
the tax authorities based on the value of its asset, including
intangible assets,
whichever is higher.
Under Rule 11UA, it is proposed to include five more valuation
methods for non-resident investors. The draft rules are awaited to
understand the proposed methods.
B – Price matching with notified entities, venture capital funds or specified funds
Where any consideration is received by a company for the issue of shares from any non-resident entity notified by the Central Goverment, 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 subject to the following:
- To the extent, the consideration from such FMV does not exceed the aggregate consideration that is received from the notified entity and
- The company has received the consideration from the notified entity within a period of 90 days of the date of issue of shares which are the subject matter of valuation.
On similar lines, price matching for resident and non-resident
investors would be available with reference to investment by
Venture Capital Funds or Specified Funds.
C – Valuation from Merchant Banker acceptable
It is proposed that for the purpose of Rule 11UA, the valuation
report by the Merchant Banker 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.
D – Safe Harbor of 10%
It is also proposed to provide a safe harbor of 10% variation in
value to account for forex fluctuations, bidding processes, and
variations in other economic indicators, etc., which may affect the
valuation of the unquoted equity shares during multiple rounds of
investment.
E – Relaxation for start-ups
Relief from angel tax provisions is available to start-ups on
the satisfaction of certain conditions1. A start-up is
considered to be eligible for exemption from 56(2)(viib) of the Act
if it is recognized by Department for Promotion of Industry and
Internal Trade (DPIIT) and the aggregate paid-up capital and share
premium after the issue/proposed issue does not exceed 25 crores.
Such a start-up is required to file a declaration in Form 2 with
DPIIT, which forwards the same to CBDT.
It is also proposed to modify Notification No. S.O 1131(E) dated 5
March 2019 so as to provide that the provisions Section 56(2)(viib)
of the Act shall not apply to the consideration received from any
person by start-ups covered in para 4 and 5 (providing above
criteria for being considered as a start-up) of Notification dated
19 February 2019 issued by the Ministry of Commerce and Industry in
the DPIIT.
F – Notification for excluded entities
It is also proposed to notify certain classes of persons being non-resident investors to whom clause (viib) of sub-section (2) of Section 56 of the Act shall not be applicable. This includes:
- Government and government-related investors such as central banks, sovereign wealth funds, international or multilateral organizations or agencies, including entities controlled by the government or where direct or indirect ownership of the government is 75% or more.
- Banks or Entities involved in Insurance Business where such entity is subject to applicable regulations in the country where it is established or incorporated or is a resident.
- Any of the following entities, which is a resident of certain
countries or specified territories having robust regulatory
framework:
- Entities registered with the Securities and Exchange Board of India (SEBI) as Category-I Foreign Portfolio Investors (FPIs).
- Endowment Funds associated with a university, hospitals or charities,
- Pension Funds created or established under the law of the foreign country or specified territory,
- Broad-based Pooled Investment Vehicle or Fund where the number of investors in such vehicle or fund is more than 50 and such fund is not a hedge fund or a fund that employs diverse or complex trading strategies.
1. The conditions were laid down in DPIIT notification G.S.R 127(E) dated February 19, 2019
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