Angel Tax for valuing investments in start-ups, notifies

The income tax department has notified rules for valuation of investments by resident and non-resident investors in startups, thus paving way for implementation of the changes brought in 2023-24 Budget.As per the changes in Rule 11UA of I-T rules, the Central Board of Direct Taxes (CBDT) provides that the valuation of compulsorily convertible preference shares (CCPS) and equity shares issued by unlisted startups can be based on the fair market value. The amended rules also retain the five new valuation methods proposed in the draft rules for consideration received from the non-residents viz., (i) Comparable Company Multiple Method, (ii) Probability Weighted Expected Return Method, (iii) Option Pricing Method, (iv) Milestone Analysis Method, and (v) Replacement Cost Method.
Effective from September 25, the changes, introduced by the Central Board of Direct Tax (CBDT), aim to streamline the valuation process.The rule governs the valuation of equity and compulsory convertible preference shares (CCPS) issued by startups to both resident and non-resident investors. One significant modification permits the valuation of CCPS to be based on the fair market value of unquoted equity shares.This adjustment provides more flexibility in determining the value of these shares, potentially benefiting startups and investors alike.The rules have also extended a 10 percent safe harbour margin to Compulsorily Convertible Preference Shares (CCPS) investments, which was originally designed for equity shares. Any amount exceeding the valuation determined after considering a 10% safe harbor margin will be classified as a taxable premium.
The amendments stem from the Finance Act, 2023, which modified Section 56 (2) (VIIIB) of the Income Tax Act, 1961, bringing foreign investment in startups under the purview of new tax rules.These modifications led to concerns among startups about the computation methodology for establishing fair market value due to discrepancies in valuation calculations between the Income Tax Act and the Foreign Exchange Management Act (FEMA). The Angel Tax, levied at a rate of 30.6%, applies to any capital raised by startups through selling shares to investors above the fair market value (FMV). In May, the CBDT released draft rules pertaining to the valuation of funding in unlisted and unrecognised startups for the purpose of imposing Angel Tax.