Valuation in early stage companies should be market driven, as in, there is an investor willing to invest and a company which is primed to grow. The discussion between them should be the guiding factor.
However, this point is highly regulated and the valuation has to be proven to the satisfaction of the tax officers. Such discretionary powers are causing heart-burn.
- We have written quite a bit on this topic. Valuation for issuance of shares: Which method to choose?
- We wrote a detailed note on the legislative issues, sometime back, which was presented to the Government by TiE, NASSCOM, IAN and others: Early stage valuations: Legislative context and continuing saga of Angel Tax
- Mumbai ITAT Provides Further Relief and Clarity on Valuation of Preference Shares
- Fund raising and valuation: Company can choose the methodology
- Regulatory Updates: Companies Registered Valuers and Valuation Amendment Rules
- Regulatory Updates: Rules for Valuation of Unquoted Shares
Due to the many changes, there is confusion of which valuation method to use, who to take the valuation certificate from, etc.
Prior to October 2017, any practising chartered accountant having an experience for more than 10 years or a merchant banker, was recognised to determine the valuation of the shares.
On 18 October 2017, the Ministry of Corporate Affairs (MCA) mandated that the valuation report has to be obtained from a Registered Valuer in certain cases. This entailed that any company issuing securities under section 42 or section 62(1) (c) of the Companies Act 2013 (the Act), would require the valuation report from Registered Valuer, who is registered with the Insolvency and Bankruptcy Board of India as per Companies (Registered Valuers and Valuation) Rules, 2017 (“Registered Valuer Rules”).
However, in terms of Rule 11 of the Registered Valuer Rules, there was a transitional arrangement until 31 January 2019, to get a valuation report from a practising CA with 10 years experience.
In addition to these requirements and conditions, the Central Board of Direct Taxes (CBDT) on 24 May 2018 amended the Rule 11 UA of Income Tax Rules, 1962, by omitting the words “or an accountant” from rule 11UA (2)(b). This change meant that the valuation report has to be obtained only from a merchant banker.
Now comes the difficulty with compliance. Compliance under section 42 of the Act and Rule 11 UA is difficult, since there are very few merchant bankers, who are Registered Valuers too.
As a result, many investors ask the companies to get valuation certificates from all the different valuers.
Scenario 1: Requirement of valuation certificate from both Merchant Banker and Registered Valuer
Any company which is not a start-up India registered and issuing equity shares/preference shares to persons who are residents in India (excluding SEBI registered funds) and such issuance is under Private Placement basis. As this issuance entails compliance under section 42, 62(1) (c) of the Act and section 56(2) of the Income Tax Act 1961, the valuation report from both merchant banker and registered valuer is mandatory.
Scenario 2: Requirement of valuation certificate only from Merchant Banker.
Any company which is not a start-up India registered and issuing equity shares/preference shares as rights issue under section 62(1) (a) (Rights Issue) of the Act either to persons residents in India or persons residents outside India, then valuation report from merchant banker is sufficient.
Scenario 3: Requirement of valuation certificate only from Registered Valuer
Under the following circumstances, the valuation report from Registered Valuer is sufficient:
(a) Any company which is not a start-up India registered and issuing debentures on private placement basis in terms of section 42, 62(1) (c) of the Act;
(b) Any company which is a start-up India registered and issuing equity shares /preference shares/ debentures;
To present this as a checklist:
|Type of Company||Scenarios||Valuation Report Requirement|
|Merchant Banker & Registered Valuer||Only Merchant Banker||Only Registered Valuer who is a Chartered Accountant|
|Start-up India registered Company (see point below)||Issuance of Equity Shares/Preference Shares (Private Placement Basis)||X||X||Yes|
|Issuance of Equity Shares/Preference Shares (Rights Issue)||X\n\n||X||Yes|
|Issuance of Debentures||X||X||Yes|
|Other Companies||Issuance of Equity Shares/Preference Shares (Private Placement Basis)||Yes||X||X|
|Issuance of Equity Shares/Preference Shares (Rights Issue)||X||Yes||X|
|Issuance of Debentures||X||X||Yes|
There are several open points.
Question on applicability of section 56(2)(x)
An open point on valuation report from merchant banker in case of issuance of shares by start-up India registered companies, still requires clarification. This is because, section 56(2)(x) of the Income Tax Act, 1961 mandates to a person who receives shares from a company to get the valuation report from a merchant banker. While the start-up company is exempted only under section 56(2)(viib), receipt of such shares by a person is not exempted. This point still requires clarification from CBDT.
Other open questions:
While it seems that the requirement of valuation report is clear under various enactments, there is still ambiguity in terms of say: (a) whom to approach in case of a person who received shares from Startup India registered company; (b) how to deal when there is difference in fair market value arrived by Registered Valuer and merchant banker. This might require approaching a valuer who is recognised under Companies Act and Income Tax Act, who is both a Registered Valuer and a merchant banker.
Happy to hear your thoughts.
 Registered Valuer means a person registered with the Insolvency and Bankruptcy Board of India in accordance with Registered Valuer Rules.
 Companies registered with Department for Promotion of Industry and Internal Trade as Start-up.
 Start-up companies are exempted from section 56(2)(viib) of Income Tax Act 1961 pursuant to notification from CBDT dated 11 April 2018.