Kartik Ravichander, firstname.lastname@example.org
Kushal Gupta, email@example.com
One of the major changes in the Finance Act of 2012 is the introduction of Section 56(2)(viib) of the Income Tax Act, 1961 (“Act”), which provides that if a company in which public is not substantially interested, issues shares at a premium, then the aggregate amount of premium, over and above the fair market value of shares will be subject to income tax. Till now no specific rules were provided and the companies had to use Net Asset Value (“NAV”) method under Rule 11UA of the Income Tax Rules, 1962 (“Rules”), to determine the fair market value of unquoted equity shares.
The Central Board of Direct Taxes (“CDBT”) vide notification no. 52/2012 (“Notification”), dated 29 November, 2012, has amended Rule 11U and 11UA of the Rules. Pursuant to the Notification the companies can use Discounted Cash Flow (“DCF”) method of valuation, for determining fair market value of unquoted equity shares, for the purposes of Section 56(2)(viib) of the Act.
Benefits to angel investment
Unlike NAV method of valuation, DCF method takes into consideration the future potential of the company and therefore the fair market value of shares determined as per DCF method is higher. Pursuant to the Notification, the companies may use DCF method and issue shares at heavy premium without attracting tax liability under Section 56(2)(viib) of the Act.
Valuation of unquoted shares as per the notification
Pursuant to the Notification, for the purposes of Section 56(2)(viib) of the Act, fair market value of the unquoted equity shares of a company may be determined by either (a) DCF method of valuation; or (b) net value of the assets of the company.
1 Valuation as per DCF Method:
(a) Valuation date: The valuation as per the DCF method has to be on the date on which the consideration is received by the company and not the date on which shares are issued by the company.
(b) Certification of valuation: The valuation will have to be certified by either a Chartered Accountant (who is not appointed by the company as its auditor under the Companies Act, 1956) or a merchant banker.
2 Valuation as per NAV method:
The old method of determining the fair market value as per the balance sheet of the company has been retained. However there have been certain modifications in the manner the valuation will be done.
(a) Balance Sheet:
For the purpose of valuing the shares as per the NAV method, the company can use (a) the balance sheet as drawn up and audited as of the valuation date (refer point 3.1(a) above) or (b) the balance sheet drawn on a date immediately preceding the valuation date, which has been approved and adopted in the annual general meeting of the company.
Pursuant to the Notification the total value assets will be determined in the following manner:
Book value of the assets – (amount paid as TDS (tax deducted at source) + Advance Tax) + amount claimed as refund under the Act – unamortised amount of deferred expenditure which does not represent the value of any asset.
Pursuant to the Notification in calculating the liabilities, reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation will not be included. However the liabilities will include:
(i) credit balance of profit and loss account will be included in liabilities; and
(ii) any amount paid as TDS as reduced by the amount claimed as refund under the Act.
The Notification has permitted the use of DCF valuation method to determine the fair market value of the unquoted shares with regards to Section 56(2)(viib) of the Act. This is a positive move on behalf of CBDT and the fact that one can value the shares of a company on the basis of its future potential, will bring much need relief to the investor community. Since, the Notification was issued on the 29th of November, 2012, the companies cannot use DCF method of valuation, for the consideration received by it, during 1 April, 2012 to 28 November, 2012.