IT Department to soon revised Valuation Standards for taxing Foreign Investments in Unlisted Corporations

The Income Tax Department is set to issue amended valuation standards under the I-T Act for determining the fair market value (FMV) of unlisted company shares for the purpose of levying tax on non-resident investments, as per and official.

The Finance Bill, 2023, has amended Section 56(2)(viib) of the Income Tax Act, bringing overseas investment in unlisted closely held enterprises, with the exception of DPIIT-recognized startups, within the tax net.

According to the official, revisions are required because the IT Act and FEMA use different procedures to calculate the FMV of unlisted company shares.

“Rule 11UA of the I-T rules will be re-prescribed taking into account the concerns expressed by stakeholders in order to harmonise it with the FEMA regulations,” the official stated.

Rule 11UA deals with determining the fair market value of assets other than immovable property. Previously, only investments in closely held companies made by domestic investors or residents were taxed above the fair market value. This was generally known as the angel tax.

According to the Finance Bill 2023, such investments beyond the FMV will be taxed regardless of whether the investor is a resident or a non-resident. The provisions would take effect on April 1 if passed by Parliament.

The startup and venture capital industries have asked for an exemption for certain types of foreign investors. The finance ministry is likely to identify which investor class these updated tax regulations would apply to in the guidelines.

Investments in startups that fulfil the necessary standards and are approved by the Department for Promotion of Industry and Internal Trade (DPIIT) would, however, be exempt from taxation.

Concerns have been raised following the proposed modifications to the Finance Bill regarding the process for calculating fair market value under two different statutes.

According to FEMA regulations, an Indian firm may not issue a capital instrument for less than the Fair Market Value assessed under FEMA legislation.

The tax would be paid under IT law on any excess price recovered over and above Fair Market Value (determined in accordance with income tax laws) when issuing shares to a non-resident.

Assume the FMV of a share is Rs 100 under FEMA law, but Rs 80 under income tax. Assume that the shares are only available to international investors for Rs 100. In such circumstances, the income tax agency will levy a charge of Rs 20 (100-80) on the beneficiary corporation.