The income tax department is likely to come out with modified valuation rules under the IT Act for ascertaining the fair market value (FMV) of shares of unlisted companies for the purpose of levying tax on non-resident investments, an official said.

The Finance Bill, 2023, has proposed amending Section 56(2)(viib) of the IT Act, thereby bringing overseas investment in unlisted closely held companies, excepting DPIIT-recognised start-ups, under the tax net.

The official said that amendments are needed as the IT act and Fema provide different methodologies for calculating FMV of shares of unlisted companies.

“Rule 11UA of IT rules will be re-prescribed taking into account the concerns expressed by stakeholders to harmonise it with the Fema regulations,” the official said.

Rule 11UA deals with determination of FMV of assets, other than immovable property.

Under the existing norms, only investments by domestic investors or residents in closely held companies were taxed over and above the fair market value. This was commonly referred to as angel tax.

The Finance Bill, 2023, has proposed such investments over and above FMV, will be taxed irrespective of whether the investor is a resident or non-resident. Once approved by Parliament, the provisions would take effect from April 1.

However, no tax would be levied on investments in startups which meet the prescribed norms and are recognised by the Department for Promotion of Industry and Internal Trade (DPIIT).

Post the amendments proposed in Finance Bill, concerns have been raised over the methodology of calculation of fair market value under two different laws.

Fema regulations mandate that the issue of a capital instrument by an Indian company shall not happen at any value less than FMV computed as per Fema laws.

Under IT law, tax would be levied on any excess price recovered over and above FMV (calculated as per the income tax laws) on issuing shares to a non-resident.

Suppose FMV of a share under Fema law is Rs 100, whereas under income tax it is Rs 80. Now, let’s assume if the shares are issued to foreign investors at Rs 100 only.

Even in such cases, the income tax department will impose tax on Rs 20 (100-80) in the hands of the recipient company.

AMRG & Associates senior partner Rajat Mohan said under income tax laws, the taxpayer can calculate FMV as per book value or as per the discounted free cash flow method certified by a merchant banker.

Whereas under Fema regulations, valuation of equity instruments is done as per any internationally accepted pricing methodology.

Nangia Andersen LLP partner Vishwas Panjiar said instead of using a prescriptive approach, the government should allow valuation to be done on the basis of any globally accepted methodology.

Also, the government should introduce tolerance limit (of say 20 per cent), similar to what is already in case of sale of immovable property, for issuing shares at more than the floor value arrived for Fema purposes, Panjiar said.