Valuation under lens of regulators
Valuation is a key driver in any corporate decision-making process whether it is a regular transaction of purchase or sale of securities or corporate actions like Merger & Amalgamation (M&A); Demerger, Business Restructuring; or any other similar transaction with shares.
Requirement of the valuation report depends upon the nature and type of transaction. Ex. Issue of shares on preferential allotment basis pursuant to section 62 (1)(c) of the Companies Act, 2013 requires a Valuation report from the IBBI registered valuer based on the premise as ‘Going concern’. The same transaction requires valuation under income tax wherein the valuer needs to use principles specified under Rule 11UA (2) of Income Tax Rules, 1962. Further, if these shares are issued to overseas investors, then one more Valuation report is needed as per Foreign Exchange Management (Non-Debt instruments) Rules, 2019 based on Arm’s Length basis (ALP).
If a Company issue shares to person resident outside India, then valuation report requirements are as follows:
CA – Companies Act; IBBI – Insolvency and Bankruptcy Board of India; I.T – Income Tax; FMV – Fair Market Value; FDI – Foreign Direct Investment; MB- Merchant Banker; CA – Chartered Accountant; CMA – Cost and Management Accountant
Note 1: Who can issue valuation report: The Fair market value has to be determined as per method prescribed (based on the balance sheet values). It can be valued by any person i.e Chartered Accountant, Cost accountant, Merchant banker, Registered Valuer or any other person including the Management. However, it is advisable to get a valuation report from an independent person.
Why Multiple valuation reports for single transaction? Presently different regulators recognize different persons for issuing valuation reports and hence, three valuation reports are required for single transaction referred above. Because object and purpose of each legislation is different. The government of India is in the process of bringing comprehensive legislation on valuation profession through Valuers Bill. Until enactment of Valuers Bill, present system will continue.
A. When Valuation is required?
| 1. Regulatory requirements
a. Companies Act/Rules b. SEBI Regulations c. Foreign Exchange Management Act (FEMA) d. Insolvency and Bankruptcy Code (IBC) & Regulations e. Income Tax Act, 1961 and rules |
2. Financial Reporting purpose
a. Purchase price allocation b. Portfolio value investment c. Fair Value Reporting d. Impairment Testing |
| 3. Deal related matters
a. Merger and Amalgamation, b. Business acquisition c. Mutual Settlement |
4. Others
a. Family settlement b. Litigation c. ESOP |
I. Regulatory requirements
a. Under Companies Act, 2013: Valuation report is required pursuant to provisions of Companies Act, 2013 under the following situations.
i. Issue of shares on preferential basis pursuant to Section 62(1) (c);
ii. Non cash transactions with directors under Section 192;
iii. Scheme of Corporate Debt Restructuring under Section 230(2)(c);
iv. Merger and Amalgamation of companies under Section 232(2)(d) and demerger;
v. Merger of a listed company with unlisted company and shareholders of listed company decided to opt out pursuant to Section 232(3)(h)(B);
vi. Purchase of minority shareholding by the acquirer on acquiring 90% or more of the issued Equity share capital of a company pursuant to Section 236(2);
vii. On winding up (Section 281);
viii. Reduction of share capital under Section 66
ix. Issue of Sweat Equity shares;
x. Valuation of Intellectual Property Rights (IPR) or know-how or value addition of unlisted companies, pursuant to Section 54(1);
xi. Conversion of loan into equity under Section 62(3);
xii. Secured Deposits –for creation of security amount for deposits under Section 73.
b. Valuation under SEBI guidelines
i. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018;
ii. SEBI (Appointment of Administrator and Procedure for refunding to the Investors) Regulations,2018;
iii. SEBI (Issue and Listing of Securitized Debt Instruments and Security Receipts) Regulations, 2008;
iv. SEBI (Real Estate Investment Trust) Regulations, 2014;
v.SEBI (Infrastructure Investment Trusts) Regulations, 2014;
vi. SEBI (Issue of Sweat Equity) Regulations 2002;
c. Valuation requirements under FEMA
Issue of shares by Indian company to persons resident outside India (PRI) or an investment by an Indian company in overseas companies by way of capital contribution (ODI) or transfer of shares between resident and non-resident requires a Valuation Report as per FEMA guidelines.
Requirement of valuation under FDI:
| Nature of issue | Valuation Report |
| Subscribers to MOA | × |
| Rights issue of shares | × |
| Preferential issue or private allotment | ✓ |
| Bonus issue | × |
| Transfer of shares between Resident of India to Resident outside India or vice-versa ( change in repatriability of shares) | ✓ |
| Transfer of shares where transferor and transferee are resident outside India
– Where there is change in repatriability – Where there is no change in repatriability |
✓
× |
FEMA compliances are not required if issue of shares is on non-repatriation basis, or if transfer from resident to non-resident is done where non-resident holds shares on non- repatriation basis. Accordingly, valuation report is not required in such cases.
d. Valuation under IBC & Regulations
i. Interim Resolution Professional (IRP) shall obtain estimate of Fair value and liquidation value of the Assets (Regulation 27/35 of CIRP regulations) ;
ii. Liquidator shall obtain valuation report (Regulation 35(2) of liquidation process regulations);
iii. Report on assets of the Company for voluntary liquidation of corporate person to be attached while filing Declaration of Solvency (Section 59 of IBC Code);
iv. The Adjudicating Authority may require an independent expert to assess the evidence for avoidable transactions (Section 46(2) of IBC).
e. Valuation under Income Tax Act, 1961
Any transaction whether purchase, sale, transfer, exchange of either tangible or intangible asset requires valuation as per the provisions of Income tax Act, 1961 for discharging applicable tax. The Act prescribes certain rules for valuation of property. Asset includes securities and Securities include— shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of alike nature in or of any incorporated company or other body corporate etc.
Hence, any transaction of issue, purchase or sale of securities (equity or preference share or debenture or other securities) requires valuation under Income Tax Act, 1961 unless exempted.
i. Purpose of Valuation under Income Tax
- To ascertain amount of capital gain for payment of capital gain tax (Section 50CA).
- To ascertain the amount of benefit/ gain received or accrued to a recipient for payment of tax under section 56(2)(x) (gift tax).
- To arrive excess premium (Angel tax) received by a company for payment of income tax under section 56(2) (viib) when shares are offered at premium.
ii. Provisions of Income Tax Act, 1961 for valuation of shares
a. Capital Gain tax – Section 50CA When a consideration received or accruing on transfer of capital asset, being unquoted equity share is less than the fair market value (FMV) of such share, then fair market value of such share shall be deemed to be the full value of consideration received or accruing as a result of such transfer.
FMV for this purpose to be determined as per Rule 11UA(1)(c)(b).
b. Gift tax – Section 56(2)(x)(c) When a person receives from any person or persons any property, other than immovable property, —
- Without consideration, the aggregate fair market value of such property exceeds fifty thousand rupees, then the whole of the aggregate fair market value of such property shall be treated as other income.
- For a consideration less than the fair market value of the property, then fair market value of such property exceeding the consideration received shall be treated as other income.
However, the following are exemptions
i) Nothing is taxable if the benefit received is less than fifty thousand rupees;
ii) Gifts to relatives and certain other transactions
In both the above cases, valuation is not required.
FMV for this purpose shall be determined as per Rule 11UA.
c. Angel Tax – Section 56(2) (viib) Where a company, not being a company in which the public are substantially interested, receives in any previous year, from any person any consideration for issue of shares that exceeds the face value of such shares, then the aggregate consideration received for such shares exceeding the fair market Value (FMV) of the shares, shall be chargeable to tax under the head “Income from other sources”.
Provided that this clause shall not apply
- by a *VC from a VC company or a VC fund or a specified fund; or
- by a company from a class or classes of persons as may be notified by the Central Government.
FMV for this purpose shall be determined as per Rule 11UA(2)(A).
Note*: VC- Venture capital
From the above, it is clear that any issue, purchase, sale, transfer of securities or purchase or sale of property of any kind between two parties require valuation as per Income tax Act, 1961 and valuation need to be carried out in accordance with Rule 11U, UA & UAA etc., of Income tax Rules, 1962.
iii. Methods of determination of Fair Market Value
a. Rule 11UA(1) (c) prescribes valuation method for transfer of securities;
b. Rule 11UA (2)(A) prescribes valuation method for issue of unquoted equity shares;
a. Valuation for Transfer of Securities (Sec 50CA & 56(2)(x) & Rule 11UA(1) (c)
| S. No | Particulars | Rule | Method | Valuation report | Who can issue |
| 1 | Quoted Securities (equity, preference or debt instruments) | 11UA(1)(c)(a) | Transaction value through stock exchange | Not required | NA |
| 2 | Unquoted equity shares | 11UA(1)(c)(b) | NAV Method as specified in the rule | Required | Note 1* |
| 3 | Unquoted preference shares or other securities | 11UA(1)(c)(c) | Estimated price it would fetch if sold in the open market | Required | Merchant banker or accountant |
*Note 1: Who can issue valuation report: The Fair market value has to be determined based on the method prescribed (based on the balance sheet values). It can be ascertained by any person i.e Chartered Accountant, Cost accountant, Merchant banker, Registered Valuer or any other person including the Management. However, it is advisable to get a valuation report from an independent person preferably IBBI Registered valuer.
b. Valuation for issue of unquoted equity shares – Section 56(viib), Rule 11UA (2)(A)
The Company can opt any one of the five methods for determination of fair market value:
|
Rule 11UA (2) |
A |
Particulars | Method to be followed | Who can issue | Available or not | ||
| R | NR | ||||||
| (a) | FMV of unquoted equity share | NAV Method as specified in the rule | *Note 1 above | ✓ | ✓ | ||
| (b) | FMV of unquoted equity share | DCF | MB | ✓ | ✓ | ||
| (c) | VC/VCC/SF | Benchmarking price | N. A | ✓ | ✓ | ||
| (d) | FMV of unquoted share –Merchant Banker – 5 methods | One of the five specified methods # | MB | × | ✓ | ||
| (e) | Notified entity – | Benchmarking price | ✓ | ✓ | |||
FMV – Fair Market Value, NAV – Net Asset Value, DCF – Discounted cash flow, MB- Merchan Banker, VC- Venture capital, VCC- Venture capital company, SF – Specified Fund, R – Resident, NR- Non resident
# specified methods: Comparable Company multiple method, Probability weighted Expected Return method, Option Pricing Method, Milestone analysis method, Replacement cost method
Note- Provisions of Rule 11UA (2) amended w.e.f. 25th September, 2023.
Any one of the above methods can be opted for arriving fair market value for issue of unquoted equity shares. However, if shares are offered to domestic investors other than overseas investors, the options mentioned under (d) is not available and they need to select one of the other four methods.
Safe Harbor Rule (Rule 11UA (4) The issue price can exceed up to 10% of the fair market value determined as per the specified methods. Valuation report obtained from Merchant Banker is valid up to 90 days from the date of issue.
iv. Practical issues and challenges in decision making
a. Issue of shares: As per section 56(2) (viib) of Income tax Act, 1961, shares shall be issued at or below the fair market value (higher cap) whereas Share Capital and Debenture Rules (Rule 13) of Companies Act, 2013 mandates that shares shall not be issued below (lower cap) the fair price per share as determined by the registered valuer. Hence, the issue price need to be fixed considering both these factors.
b. Rights issue with dis-proportionate basis: If an unlisted Company offers rights issue to its existing shareholders on dis-proportionate basis, then valuation report is required in such a case to identify the benefit accrued due to such dis-proportionate allotment. However, there are contrary judgements on this issue.
c. Rights renouncement attract tax If an existing shareholder renounces his right in favour of other person, then are liable for tax. Person renouncing the right is liable for income tax on the value of rights renouncement and recipient is liable for income tax on the benefit received.
d. Transfer of shares If unquoted equity shares are sold below the fair market value, then fair market value of such shares are taken as consideration for sale of shares and accordingly the capital gain is calculated (tax impact to seller) (Section 50CA).
In the same transaction, benefit accrued to a buyer is ascertained and taxed as per section 56(2)(x).
To avoid such additional income tax liability, it is recommended to transfer the shares at fair market value always.
v. Summary of valuation requirements as per Income Tax Act
| Particulars | Valuation |
| A. Issue or transfer of Listed securities (Equity shares, preference shares, or debt instruments) | Not required.
The market price is considered as FMV |
| B. Un quoted equity shares | |
| i. Rights issue of shares | Not required unless allotment is on dis-proportionate basis. In such a case there are contrary judgements |
| ii. Issue of equity shares on Preferential basis | Required unless preferential offer is made at par value |
| iii. Bonus shares | Not required. |
| iv. Shares buy back | Not required as the Company pays buy back tax |
| v. Exchange of shares during amalgamation, merger or demerger | Not required. |
| vi. Other transfer of shares | Required |
| C. Unquoted securities other than equity share (issue or transfer)
Preference shares, debentures or other securities |
Required from Merchant Banker or Accountant |
–
| From the foregoing it can be said that one valuation report is required for taking commercial decision like issue, purchase or sale of shares and one more valuation report is required for the same transaction as per the provisions of income tax purpose unless exempted. |
B. Why valuation Report is required when it is not mandatory under law?
- It facilitates the Board to take appropriate decisions.
- Non-Executive and Independent Directors can participate in decision making process when there is a valuation report.
- It ensures that interest of Minority shareholders is protected against oppression.
- Good Corporate Governance practice.
C. Who is authorised to do Valuation? :As per Rule 4 of IBBI Companies (Registered Valuers and Valuation ) Rules 2018, there are three types valuers for valuation of various kinds of assets. They are Land and Building (L &B), Plant and Machinery (P & M) and Securities or Financial Assets (SFA). Land and Building and Plant & Machinery (P &M) valuer can value respective asset only. However, SFA Valuer needs to carryout business valuation of a Company and arrive Enterprise Value (EV) and then value per share.
Valuation of Securities or Financial Assets -SFA As discussed supra, different enactments require valuation of shares to meet their objectives and they have recognized appropriate person who can issue the valuation report to meet their object. Details of legislation and authorised person to issue the report are as follows:
| Statutes | Valuation by |
| Companies Act/Rules | IBBI Registered Valuer |
| SEBI Regulations | Registered Valuer-only in some Cases |
| Latest circular dated 3rd Nov 2020 –for merger RV report in place of CA M.B | |
| Income Tax Act/Rules | CA/Merchant Bankers\Management or RV in some cases |
| FEMA | CA/Merchant Bankers/Cost Accountant |
| IBC Acts and regulations | IBBI Registered Valuer |
| Ind AS | IBBI Registered Valuer- (Clarified by ICAI) |
D. Valuation approaches. There are three valuation approaches namely Market approach, Income approach and Cost approach. The Valuer has to select appropriate approach depending upon valuation premise.
E. Restriction on using Limitation, Caveat and Disclaimers (LCD): The valuation is carried out by the valuer based on the information provided by the Management and the valuer shall validate the information provided to him and satisfy himself about correctness of the data prior to use. LCD’s can be provided fairly and these LCDs cannot disclaim entire responsibility of the valuer. In recent case AGRA PORTFOLIO PVT. LTD. VERSUS PR. COMMISSIONER OF INCOME TAX – 1, & ANR.-ITA 1385/2018, Delhi high court held that valuation report of M/s SPA Capital Advisors Ltd. has given a disclaimer as under: “In preparing the Final Report, SPA has relied upon and assumed, without independent verification, the truthfulness, accuracy and completeness of the information and the financial data provided by the company. SPA has therefore relied upon all specific information as received and declines any responsibility for the results presented be affected by the lack of completeness or truthfulness of such information”.
Court held that the Valuer has to validate and test check the information given under circumstances and if he satisfies himself about the correctness of the data, he can use the same for valuation purpose. Regulator will accept the valuation report provided LCD’s are reasonable and information used for arriving the value has been validated and acceptable. If the report totally disclaims the information used in valuation, then regulator or other uses will not use the report.
Conclusion: As discussed above, the importance of valuation is gaining attention of all stakeholders including regulators. However, Industry and valuation profession are facing few challenges due to lack of single monitoring agency for valuation. The draft Valuers Bill is expected to bring comprehensive legislation regulating valuation profession. It is expected that Valuers bill will address challenges faced by Industry and valuers.
****
Disclaimer: Views expressed here are personal views of the author and should not be considered as legal opinion.
Author CS Chandra Sekhar Kandukoori | M.Com, LLB, ACS, ACMA, (CA), qualified social auditor | Practicing Company Secretary, Insolvency Professional and Registered Valuer. Author can be reached at chandra@kcsassociates.co.in Mobile: 99806 99119
Author Bio
