Finance Minister Nirmala Sitharaman in Budget 2023 proposed a revision in what is widely referred to as the angel tax provision. The Finance Bill, 2023, has sought to address a gap that exists in Section 56(2)(viib) of the Income Tax law. The provision says that when a privately held company issues shares at a particular price that is greater than fair market value (FMV), tax is charged to the amount received in excess of FMV. With revisions proposed in the Budget, the government is expanding specific anti-abuse provisions, and bringing non-resident investors within the ambit of Section 56(2)(viib) on the Income Tax Act, 1961. Amit Agarwal, Partner, Nangia Andersen India, explains how this step could perhaps a negative effect on the funding of India Inc.
Explained: Section 56(2)(viib) of ITA, 1961 – Existing provision
Earlier, this section provided that where a company (not being a company in which the public are substantially interested) receives in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income-tax under the head ‘Income from Other Sources’.
- Rule 11UA of the Income-tax Rules is prescribed for the computation of the fair market value of unquoted equity shares. The said rule recommends that the valuation of unquoted equity shares ought to be undertaken using Net Asset Value method or Discounted Cash Flow methodology and duly certified by a Merchant Banker.
Earlier the Section was applicable only where the consideration for issue of shares is received by a Company from a Resident, and was not applicable in case the consideration (share application money or share premium) was received from non-residents.
Amendment proposed under Finance Bill 2023 under Section 56(2)(viib) of the Act:
In Finance Bill, 2023, it is proposed to include the consideration received from non- resident also under the ambit of clause 56 (2)(viib) by removing the phrase ‘being a resident’ from the said clause.
Impact of the Proposed Amendment
The amendment seeks to expand the applicability of Section 56(2)(vii)(b) by making it applicable on receipt of consideration for issue of shares from any person irrespective of his residency status (resident and non-resident both) and thus aims at extending the fair valuation principles governing issuance of shares to investments made by a non resident in a domestic company.
In simpler terms, any investment by a Non Resident in Shares (Equity or Preference) a Domestic Company shall now require an Income Tax valuation report from a Merchant Banker and the investment ought to be made at a value less than the fair market value of shares of the domestic company, to avoid tax implications. The said valuation report shall be required irrespective where the investment is made by way of a Rights issue or a preferential issue by a Non-resident. It follows that even investments by NRI’s / Strategic investments in private limited companies would now require justification under Income Tax. It’s important to mention here that under FEMA the valuation norms prescribe that any investment in equity shares by a Non resident has to be at a value higher than the Fair Market Value under FEMA.
Thus, the foreign investor has to now exactly match the valuation under FEMA and Income Tax (under discounted cash flow method) to avoid any complications from a FEMA and Income Tax perspective. In practical terms the pricing of equity shares in a M&A transaction is governed by independent negotiations. With the introduction of new amendment, each of such transactions needs to be justified under Income Tax and the per share price should ideally match with the report of the Merchant Banker and Chartered Accountant (under FEMA), which therefore looks quite unpractical.