The government has announced its plans to make significant changes to the tax regulations concerning angel investors. The government has outlined its proposal to expand the valuation methods used for calculating investment value and revise the tax requirements for angel investors.
Understanding Angel Tax
The term "angel tax" refers to the tax that unlisted companies must pay on funds raised through the issuance of shares in off-market transactions, if the raised amount exceeds the fair market value of the company.
Proposed Amendments to Rule 11UA
The Central Board of Direct Taxes (CBDT) has put forward amendments to Rule 11UA, which deals with the valuation of shares for the purpose of section 56(2)(viib) of the Income-tax Act, 1961. These amendments aim to address concerns regarding the applicability of Tax Collection at Source (TCS) on shares issued to non-residents.
Expansion of Valuation Methods
Currently, Rule 11UA prescribes two valuation methods, namely Discounted Cash Flow (DCF) and Net Asset Value (NAV), for resident investors. The government intends to introduce five additional valuation methods specifically for non-resident investors, in addition to the existing DCF and NAV methods.
Resolving Incongruence in Valuation Mechanism
The investor community has been raising concerns over the inconsistency between the valuation mechanism outlined in the Foreign Exchange Management Act (FEMA) rules and the Income Tax Rules. While FEMA accepts internationally accepted pricing methodologies and sets a minimum or floor price for shares, the Income Tax Rules limit the share price to the fair market value (computed through the DCF or NAV method), and any price exceeding this cap is taxed.
Consideration for Shares from Non-Resident Entities
According to the government's statement, if a company receives consideration for issuing shares from a non-resident entity notified by the Central Government, the price of the equity shares corresponding to such consideration may be considered as the Fair Market Value (FMV) of the shares. However, this is subject to two conditions: first, the consideration from the FMV should not exceed the total consideration received from the notified entity, and second, the company must receive the consideration from the notified entity within ninety days from the date of issuing the shares being valued.
Price Matching for Resident and Non-Resident Investors
To ensure equity between resident and non-resident investors, price matching will be implemented for investments made by Venture Capital Funds or Specified Funds.
Enhancing the Valuation Process
The government has proposed several key enhancements to the valuation process for unlisted equity shares. Firstly, it is suggested that the valuation report prepared by a Merchant Banker will be considered acceptable if it is not older than ninety days from the date of issuing the shares being evaluated. This ensures the relevance and accuracy of the valuation.
Additionally, a safe harbor of 10 percent variation in value will be introduced to account for factors such as forex fluctuations, bidding processes, and variations in economic indicators. This provision aims to accommodate potential fluctuations in the value of unquoted equity shares during multiple rounds of investment.
Public Feedback and Finalization
The draft Rules containing these proposals will be open for public comments for a period of ten days. After considering the feedback received, the final rules will be officially notified.
The government's proposed changes to tax regulations for angel investors aim to address concerns raised by the investor community and create a more consistent and fair valuation process. These changes will have significant implications for both resident and non-resident investors, as well as for the overall investment landscape in the country.