The Pre-2025 Framework and Why It Changed

Prior to the Finance Act 2025, the valuation provisions for transfer of unlisted shares were primarily governed by Section 56(2)(x) of the Income Tax Act, 1961, read with Rule 11UA of the Income Tax Rules, 1962. The law required that where shares were transferred at a price below their fair market value (FMV), the difference was taxable as income from other sources in the hands of the recipient.

However, the existing framework had gaps — particularly around the seller's side, where excess consideration received was not symmetrically taxed under the same provision. The Finance Act 2025 addresses these asymmetries and introduces greater rigour around what constitutes an acceptable valuation.

Key Amendments under Finance Act 2025

The Finance Act 2025 amends Section 56(2)(x) to extend its scope and bring symmetry to the taxation of share transfers. The key changes are:

Buyer-side taxation (existing, strengthened): Where any person receives shares of an unlisted company at a consideration below FMV, the shortfall (FMV minus consideration) is chargeable to tax as income from other sources in the hands of the buyer. The Finance Act 2025 tightens the threshold — the earlier tolerance band of Rs. 50,000 aggregate per year continues, but the valuation methodology has been further prescribed.

Seller-side taxation (Section 50CA, reinforced): Section 50CA deems the FMV to be the full value of consideration for computing capital gains in the hands of the seller where shares are transferred at below FMV. The Finance Act 2025 aligns the FMV definition under Section 50CA with the amended Rule 11UA methodology, ensuring consistency between buyer and seller valuations.

Mandatory valuation report: For transactions above prescribed thresholds, a valuation report from a SEBI-registered Merchant Banker or a Chartered Accountant is now required to support the FMV used. This is a critical compliance requirement that was previously more loosely enforced.

FMV Determination Methods under Amended Rule 11UA

Rule 11UA prescribes the methods for computing FMV of unquoted equity shares. Post the Finance Act 2025 amendments, the prescribed approaches are:

Net Asset Value (NAV) method — default: FMV = (Book value of assets less specified liabilities) / (Number of outstanding shares). This is the floor value and is computed based on the balance sheet as of the valuation date.

Discounted Cash Flow (DCF) method — permitted: For companies with projections, the DCF method as determined by a Merchant Banker may be used. This allows growth-stage companies to use a forward-looking valuation. However, the methodology and assumptions must be documented and defensible.

Price of recent transaction — for certain cases: Where shares have been issued by the company to a venture capital fund or a specified class of investors within the preceding 90 days, the price of such transaction may be used as FMV. The Finance Act 2025 retains this safe harbour but clarifies that the transaction must be at arm's length and to an unrelated party.

It is important to note that the method chosen must be consistently applied and the valuation report must specify the method, assumptions, and basis clearly. Tax authorities have been increasingly scrutinising valuation reports, particularly in startup transactions.

Exemptions and Safe Harbours

Not all share transfers trigger Section 56(2)(x). The following categories are explicitly exempt:

  • Transfers between specified relatives (as defined under the Act)
  • Transfers pursuant to a will or inheritance
  • Transfers under a court or tribunal order (including NCLT-approved restructurings)
  • Transactions covered by SEBI regulations (listed companies)
  • Transfers to specified funds, trusts, institutions, or universities
  • ESOPs issued by eligible startups recognised by DPIIT (within limits)

For startup transactions, DPIIT-recognised startups continue to have a specific exemption from angel tax (Section 56(2)(viib)) for issue of shares, which has now been extended and clarified under Finance Act 2025 — though this applies to issuance, not secondary transfers.

Practical Implications for Startups and Investors

For founders and early investors executing secondary transfers — including ESOP buybacks, secondary sales to new investors, or founder share transfers — the Finance Act 2025 changes have direct impact:

Always obtain a valuation report before execution. Whether you are the buyer or the seller in a secondary transaction, having a contemporaneous FMV valuation from a qualified professional is now non-negotiable. Without it, both sides are exposed to reassessment.

Align FMV with primary round valuation. Where a primary funding round has been recently closed, the round price is often used as reference FMV for secondary transfers. Ensure the valuation report explicitly bridges the two.

Understand the tax exposure on both sides. A buyer acquiring shares at a discount to FMV will recognise taxable income under Section 56(2)(x). A seller transferring below FMV will have deemed consideration under Section 50CA. Both need to be planned for.

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.