I-T dept notifies ‘Angel Tax’ rules for valuing investments in startups

The Income Tax Department has announced rules for valuation of equity shares and compulsorily convertible preference shares issued by startups to resident and non-resident investors.

As per the amendments in Rule 11UA of the IT Rules, which will come into effect from September 25, the Central Board of Direct Taxes (CBDT) stipulates that the valuation of compulsorily convertible preference shares (CCPS) can also be based on the fair market value of unlisted shares.

The amended rules also retain the five new valuation methods proposed in the draft rules for compensation received from non-residents, namely (i) Comparable Company Multiple Method, (ii) Probability Weighted Expected Return Method, (iii) Option Pricing Method, (iv ) Milestone Analysis Method, and (v) Replacement Cost Method.

Nangia & Co LLP Partner Amit Agarwal said the amendments to Rule 11UA of the Indian Income Tax Act bring positive changes by providing flexibility to taxpayers through multiple valuation methods, simplifying the consideration of valuation date, encouraging venture capital investment, facilitating investments of registrants entities are facilitated and clarity is provided. on CCPS and encouraging foreign investment.

“Including a tolerance threshold for small valuation differences further increases efficiency and fairness in tax assessments, ultimately benefiting both taxpayers and the government.

“These changes provide taxpayers with a wider range of valuation methods to choose from, including internationally recognized approaches, attracting foreign investment and promoting clarity. In addition, the notified final rule introduces an additional sub-clause specifically related to CCPS,” Agarwal said.

AKM Global Tax Partner Amit Maheshwari said the new angel tax rules have very much taken care of an important aspect of the CCPS valuation mechanism, which was not the case earlier as most of the investments in India by VCs are only through the CCPS route.

“The extension of the 10 percent safe harbor for CCPS investments, as it was earlier intended for equities, will provide the necessary margin of safety to absorb currency fluctuations and is a welcome move,” Maheshwari added.

The CBDT had in May come up with draft rules on valuation of funding to unlisted and unrecognized startups for levying income tax, commonly referred to as ‘Angel Tax’, and had sought public comments on the same.

The amended rules are intended to bridge the gap between the rules set forth in FEMA and the income tax.

Until now, only investments by domestic investors or residents in closely held companies or unlisted companies have been taxed above fair market value. This was commonly called an angel tax.

The Finance Act 2023 states that such investments will be taxed in addition to the FMV, regardless of whether the investor is a resident or non-resident.

Following the changes to the Finance Act, concerns have been raised about the methodology for calculating fair market value under two different laws.