Applicability of Valuation Certificate under FEMA and Companies Act

In India, the valuation of shares plays a crucial role in corporate transactions such as fundraising, mergers, employee stock options, and foreign investments. Two major legal frameworks govern share valuation: the Foreign Exchange Management Act (FEMA) and the Companies Act, 2013.

Valuation certificates serve as essential instruments in promoting transparency, fairness, and regulatory compliance within both domestic and international corporate transactions. The Companies Act, 2013 and FEMA, along with their respective subordinate rules, regulations, and Master Directions, prescribe specific scenarios where valuation certifications are mandatory. These legal mandates are designed to uphold the integrity of financial transactions, safeguard stakeholder interests, deter asset mispricing, and ensure consistent regulatory oversight across a wide range of corporate activities.

This article provides a detailed examination of the applicability and requirements surrounding valuation certificates under both statutory frameworks, clarifying when such certifications are necessitated, the methodologies to be followed, and the authorized professionals qualified to issue them.

Why is Share Valuation Important?

Valuation determines the fair price of shares for transactions between the company and various stakeholders—investors, employees, or other businesses. It helps in:

• Complying with regulatory norms
• Preventing tax evasion or underreporting
• Ensuring fairness to shareholders
• Avoiding legal and financial disputes

VALUATION REQUIREMENTS UNDER THE COMPANIES ACT, 2013

The Companies Act, 2013, and the associated rules place significant emphasis on the valuation of shares and assets in various corporate transactions to ensure transparency, fairness, and legal compliance. Accurate valuation is particularly critical when companies issue shares, buy back securities, or undergo mergers or restructurings.

When is Valuation Required?
Under the Companies Act, share valuation is required in the following scenarios:

Valuation Norms:

• Valuation must be conducted by a Registered Valuer as per the provisions of Section 247 of the Companies Act, 2013 read with Companies (Registered Valuers and Valuation) Rules, 2017.
• The valuer must be registered with the Insolvency and Bankruptcy Board of India (IBBI).
• The valuation report must justify the price using accepted methods such as:
  • Discounted Cash Flow (DCF)
  • Net Asset Value (NAV)
  • Market price method (for listed companies)
  • Comparable Company/Transaction approach

Key Considerations:

• The pricing must be justified with proper financial and market data.
• Documentation of the valuation report is mandatory for regulatory and audit purposes.
• Non-compliance may attract penalties and regulatory scrutiny.

VALUATION UNDER FEMA (FOREIGN EXCHANGE MANAGEMENT ACT, 1999)

The Foreign Exchange Management Act (FEMA), 1999, governs all foreign exchange transactions in India, including foreign investment in equity shares and transfer of shares between residents and non-residents. A key compliance under FEMA in such transactions is the valuation of shares, which ensures that pricing is in line with fair market value (FMV) norms to prevent capital flight or undervaluation.

Valuation is mandatory under FEMA in the following transactions involving foreign investors or shareholders:

Pricing Guidelines under FEMA:

FEMA mandates that:

• For issue of shares to a non-resident, the price should not be less than the fair market value determined as per internationally accepted pricing methodologies.
• For transfer of shares from resident to non-resident, the transfer price must be equal to or higher than the fair market value.
• For transfer from non-resident to resident, the transfer price must be equal to or lower than the fair market value.

Valuation Methods Permitted:

• Valuation must be done by:
  • A SEBI-registered Merchant Banker, or
  • A Chartered Accountant (CA) with experience in valuation
• Common valuation methods include:
  • DCF method
  • NAV method
  • Comparable company analysis
  • Market Price Method

Regulatory Framework:

• FEMA (Non-Debt Instruments) Rules, 2019
• Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019

Conclusion

The importance of valuation under both the Companies Act, 2013 and FEMA, 1999 lies in its role in fostering regulatory compliance, protecting stakeholder interests, and promoting financial integrity. From issuing securities to mergers and foreign investments, valuation certificates issued by qualified professionals help ensure fairness, accuracy, and transparency.

In an increasingly globalized business environment, adherence to these valuation norms is not just a matter of legal obligation but a fundamental pillar of good governance and investor confidence.

*****

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.