Section 56(2)(viib) & Rule 11UA(2) : Decoding the amendment in section 56(2)(viib) of the Income Tax Act and draft sub rule 2 of rule 11UA of the income tax Rules
In Finance bill 2023, the government of India has bite the bullet with the amendment in section 56(2)(viib) by cementing the provisions for resident as well as non-resident investor for the purpose of issue of shares. This amendment has direct impact on FDI inflow to India as in year 2022 as India was ranked 7th in the terms of Global Economy for FDI and ranked 3rd in startup ecosystem. Thus, it was the need of the hour was to assess the impact on FDI inflow and startups ecosystem. Post consultation with stakeholder, government has come-up with the amendment in Section 56(2)(viib) and the rules for valuation of share of the companies in which public are not substantially interest. Let’s unfold the provision after amendment in law:
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, the aggregate consideration received for such shares as exceeds the fair market value of the shares” than consideration to the extent exceeding fair market value shall be chargeable to tax under the head Income From Other Source.
Provided that above provision shall not apply where the consideration for issue of shares is received from :
1. by a venture capital undertaking from a venture capital company or a venture capital fund or a specified fund; or
2. by a company from a class or classes of persons as may be notified by the Central Government in this behalf:
*ANNEXURE
List of Notified Countries/Territories
· Australia
· Austria · Belgium · Canada · Czech Republic · Denmark · Finland |
· France
· Germany · Iceland · Israel · Italy · Japan · Korea |
· New Zealand
· Norway · Russia · Spain · Sweden · United Kingdom · United States |
Analysis of Provision: Finance Act 2023 has cemented the difference between resident as well as non-resident for applicability of section 56(2)(viib). Now any amount received by the company (in which public is not substantially interested) exceeding the fair market value for issue of shares will be chargeable to tax under the head income from other sources. Further, The following category of person has been notified in case which the provision of the section 56(2)(viib) will not be applicable:
Notified Entities |
Specified Country /Territory |
Consideration received for Issue of shares by |
(I) Category 1 Foreign Portfolio Investor registered with SEBI;
(II) Endowment funds associated with a university, hospitals or charities. (III) Pension Fund (Registered under Indian or Foreign Law) (IV) Broad Based Pooled Investment Vehicle or fund where the number of investors in such vehicle or fund is more than fifty and such fund is not a hedge fund or a fund which employs diverse or complex trading strategies. |
· Australia
· Austria · Belgium · Canada · Czech Republic · Denmark · Finland · France · Germany · Iceland · Israel · Italy · Japan · Korea · New Zealand · Norway · Russia · Spain · Sweden · United Kingdom . United States |
Closely held company in which public is substantially not interested |
Apart from above, The Ministry of Finance has issued draft amendment to amend Rule 11UA of the Income tax rules via notification no F. No. 370142/9/2023-TPL(part-I) dated 26 May 2023 to in line the valuation methodologies with provisions of Section 56(2)(viib). Broadly the guidelines for valuation of share as per draft rule is as hereunder:
Valuation Methodologies For Valuation Of Unquoted Equity Shares Where Consideration Received From Resident | Valuation Methodologies For Valuation Of Unquoted Equity Shares Where Consideration Received From Non – Resident |
(a) NAV Method
[(A- L) x [PV/PE]] (b) Discounted Free Cash Flow method. (c) FMV shall be deemed Equal to the Consideration received by Venture Capital Undertaking from Venture Capital Company within period of 90 days form date of such issue; (d) FMV shall be deemed Equal to the Consideration received by a company from entity notified under clause (ii) of the first proviso to clause (viib) of sub[1]section (2) of section 56 within period of 90 days form date of such issue;
|
(a) NAV Method
[(A- L) x [PV/PE]] (b) Discounted Free Cash Flow method. (c) FMV shall be deemed Equal to the Consideration received by Venture Capital Undertaking from Venture Capital Company within period of 90 days form date of such issue; (d) Determined by Merchant Banker using any of the following method: – Comparable Company Multiple Method; – Probability Weighted Expected Return Method; – Option Pricing Method; – Milestone Analysis Method; – Replacement Cost Methods; (e) FMV shall be deemed Equal to the Consideration received by a company from entity notified under clause (ii) of the first proviso to clause (viib) of sub[1]section (2) of section 56 within period of 90 days form date of such issue; |
Some further notable points of draft amendments of Rule 11UA is as follows:
Since, it is news in transition, therefore we should expect some change in final position of law for valuation of shares under subrule 2 of Rule 11UA for the purpose of Section 56(2)(viib).
Disclaimer: All information & views expressed above are my own and not representing any legal opinion. It would be better if you write to me on carrpandey@gmail.com for any further inquiries. You can also reach me +91-8882214254.
Dear Sir, I recently read your article on Tax Guru and found it to be very informative and well-written.
Your writing style was clear, concise, and engaging, making it easy for me to understand complex taxation matters. The article was also relevant to my needs and interests, as it helped clarify some concepts that I was previously unclear about.
Thank you for sharing your knowledge on this important topic. I look forward to reading more of your work in the future.
Thank you so much Rohit for your kind words!
Dear Sir,
I recently read your article on Tax Guru and found it to be very informative and well-written.
Your writing style was clear, concise, and engaging, making it easy for me to understand complex taxation matters. The article was also relevant to my needs and interests, as it helped clarify some concepts that I was previously unclear about.
Thank you for sharing your knowledge on this important topic. I look forward to reading more of your work in the future.