Income Tax Department notifies 'Angel Tax' rules for valuing investments in startups

The Income Tax Department has introduced new rules regarding 'Angel Tax', outlining the procedures for assessing the value of shares issued by unlisted startups to investors. 

The amendment, which is part of the Finance Act, 2023, includes the consideration received from non-residents for the issuance of shares by an unlisted company under section 56(2)(viib) of the Income-tax Act, 1961.

The section states that if the consideration for the issuance of shares surpasses the Fair Market Value (FMV) of the shares, it will be subject to income tax under ‘Income from other sources’. T

he government, maintaining its commitment to stakeholder involvement in law drafting, had invited suggestions and feedback from the public and stakeholders on Draft Rule 11UA for valuation methods for calculating the Fair Market price, as announced in a press release on 19th May 2023.

After considering the received suggestions and conducting detailed discussions with stakeholders, Rule 11UA has been revised as per notification no. 81/2023 dated 25th September 2023.

The revised rule includes several key changes:

• Besides the existing Discounted Cash Flow (DCF) and Net Asset Value (NAV) methods for share valuation available to residents, five additional valuation methods are now available for non-resident investors. These are the Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, and Replacement Cost Method.
• For shares issued to any non-resident entity notified by the Central Government, the price of the equity shares corresponding to such consideration may be considered as the FMV for both resident and non-resident investors, under certain conditions.
• Price matching for resident and non-resident investors will be available in relation to investment by Venture Capital Funds or Specified Funds.
• Specific valuation methods have been provided for calculating the FMV of Compulsorily Convertible Preference Shares (CCPS).
• A safe harbor provision allowing a 10% variation in value has been included.

What is the aim of these changes?

According to reports, The modification aims to expand valuation methodologies to incorporate globally accepted methods and ensure broad parity between resident and non-resident investors.

The strategic move is seen as a significant step towards providing a clear and equitable framework for startup valuations, offering a more comprehensive and inclusive approach to both domestic and international investors in the Indian startup ecosystem.

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