Two Distinct Contexts: Issuance vs Transfer
The valuation of equity shares of unlisted companies arises in two distinct legal contexts under Indian tax law, each governed by different provisions and carrying different consequences:
Issuance of shares — where a company allots new equity shares to investors. Here, the primary concern is whether the issue price exceeds FMV, which can trigger tax under Section 56(2)(viib) (commonly referred to as "angel tax") in the hands of the company.
Transfer of shares — where existing shares are sold by one shareholder to another. Here, both the buyer (Section 56(2)(x)) and the seller (Section 50CA) face tax consequences if the consideration deviates from FMV.
Finance Act 2025 has refined both frameworks, and it is important to address them separately before understanding how they interact.
Valuation at Issuance — Section 56(2)(viib) and Angel Tax
Section 56(2)(viib) provides that where a closely held company receives consideration for issue of shares that exceeds the FMV of such shares, the excess is taxable as income from other sources in the hands of the company. This is the angel tax provision.
Who does it apply to? It applies to any closely held company (a company in which the public are not substantially interested) receiving consideration in excess of FMV. Post Finance Act 2023, it was extended to non-resident investors as well — a significant change that impacted foreign VC and PE investments into Indian startups.
Finance Act 2025 clarification: The Finance Act 2025 clarifies certain valuation methodologies and provides additional guidance on what constitutes an acceptable valuation for the purposes of this section. The CBDT-prescribed methods under Rule 11UA remain the primary framework, but the Finance Act 2025 also provides that valuations conducted by specified category of investors (sovereign funds, pension funds, broad-based funds) using internationally recognised methodologies may also be acceptable in prescribed circumstances.
DPIIT-recognised startup exemption: Startups recognised by DPIIT and meeting prescribed conditions are exempt from Section 56(2)(viib). This exemption was introduced earlier but Finance Act 2025 retains and clarifies it. To avail the exemption, the startup must: (a) be incorporated as a private limited company, (b) be recognised by DPIIT, (c) not have aggregate paid-up share capital and share premium exceeding Rs. 25 crores post-issue (excluding funding from specified investors), and (d) not have made investments in specified assets.
The Rs. 25 crore threshold does not include consideration received from venture capital companies, specified funds, or non-resident investors in certain cases — making it important to carefully compute what counts towards this cap.
FMV Computation for Equity Shares — Rule 11UA Methods
Rule 11UA of the Income Tax Rules prescribes the methodology for computing FMV of unquoted equity shares. As amended to align with Finance Act 2025, the key methods are:
Method 1 — NAV (Book Value) Method: This is the default method and produces a floor value. The formula is:
FMV = (A + B + C + D – L) × (PV / PE)
Where: A = Book value of assets, B = Market value of quoted investments, C = FMV of unquoted investments, D = FMV of other assets not in balance sheet, L = Book value of liabilities, PV = Paid-up value of shares being valued, PE = Total paid-up equity share capital
Certain assets are excluded from this computation including advance tax paid, unamortised deferred expenditure, and certain other items.
Method 2 — DCF Method (for issuance only): For the purposes of Section 56(2)(viib), companies may use the DCF method as determined by a SEBI-registered Merchant Banker. This is the preferred method for high-growth startups where NAV understates intrinsic value. The Merchant Banker's report must be a formal valuation report with documented assumptions, projections, and methodology.
Method 3 — Recent Transaction Price: Where shares have been issued by the company within the preceding 90 days to a venture capital company, venture capital fund, or specified investor at a price determined through arm's-length negotiation, that price may be taken as FMV. This safe harbour is particularly useful for startups that have recently closed a primary funding round.
Practical Compliance Steps for Equity Issuance
For a company issuing equity shares — whether in a funding round, rights issue, or ESOP exercise — the following steps are recommended:
Step 1 — Determine applicable exemption. Check whether the DPIIT startup exemption applies. If yes, ensure the Rs. 25 crore paid-up capital threshold is not breached by the proposed issuance and obtain the DPIIT recognition certificate.
Step 2 — Commission a valuation report. Even if exempt, a valuation report protects against future scrutiny. For non-exempt companies, it is mandatory. The report should use an appropriate method (NAV as floor, DCF for growth companies) and be signed by a SEBI-registered Merchant Banker or CA.
Step 3 — Issue shares at or above FMV. The issue price must equal or exceed the FMV computed in the valuation report. Any shortfall (issue below FMV) is irrelevant from Section 56(2)(viib)'s perspective — the provision is triggered only when consideration exceeds FMV. However, note that FEMA regulations separately require shares issued to non-residents to be at or above FMV.
Step 4 — File FC-GPR if non-resident investor. For foreign investment, the FC-GPR filing with RBI must include the valuation certificate confirming the issue price is not less than FMV. The valuation certificate must be issued by a SEBI-registered Merchant Banker.
This article is for informational purposes only and does not constitute legal, tax, or financial advice. Please consult with a qualified professional for advice specific to your situation. Maroon Advisors would be delighted to assist — get in touch.