Angel Tax which is governed by Section 56(2)(viib), was introduced in the Income Tax Act from the Assessment Year 2013-14 via finance bill, 2012 as a step to take up the circulation of unaccounted money in the name of share premiums which were received by private companies or closely held companies.
This provision of income tax act hereby aims to bring angel tax into the taxation brackets which means the share premium which exceed the fair market value of shares, particularly those lacking underlying value to justify the premium, helping to prevent unjust enrichment without any payment of tax legitimately.
In the private limited companies, the valuation plays a crucial role in determining the fair market value of the shares under this provision, as it plays important role in influencing the assessment proceedings. Even the Judicial pronouncements have established that valuation, particularly based on projected or estimated numbers, is not an exact science but relies on reasonable approximations, recently we have seen the importance of valuation at shark tank India also.
Legal analysis of Section 56(2)(viib) and Rule 11UA raises several key issues, let's discuss it in short!
1. Relevant Trigger Date shall be Share allotment date, not share application date, triggers the provision.
2. The use of estimated numbers in the Discounted Cash Flow (DCF) method valuation is permissible.
3. AO cannot reject the method that is hereby chosen by the assessee or shall not suppose to independently evaluate shares using any other method, different to that chosen by assessee
4. The provision does not apply to transactions between holding and subsidiary companies.
5. Angel Tax applies at the time of issuance of right shares i.e. shares issued to give a preferential treatment to existing shareholders, but it is not applicable not in cases where additional shares are issued on pro rata basis to existing shareholders can say bonus shares
6. Angel Tax is applicable upon the conversion of Compulsory Convertible Debentures also known as CCD in equity shares
7. Angel Tax does not apply to share issuance post-amalgamation to shareholders of the amalgamating company.
In short, it is not applicable in case of related party transitions
How can we determine the Fair Market value of the share issued by Pvt Ltd company?
Section 56(2)(viib) determines FMV as under:
(a) Valuation of issued share as per rule 11UA
(b) Substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature
(A) or (b) whichever is higher
How it is calculated?
Fair market value of unquoted equity shares = (A+B+C+D-L) x PV/PE
Where
- A - Book value of all the assets of the company (except those mentioned at B, C and D below) less any income tax paid in form of Advance tax/TDS/TCS (net of refund) and any amount shown in the balance sheet as asset inclusive of unamortized amount of deferred expenditure which does not represent the value of any asset
- B - Fair market value of any kind of Jewellery and artistic work based on the valuation report received by a registered valuer
- C - Fair market value of shares or securities as determined according to this rule
- D - Stamp duty value in respect of any immovable property held by company
- L - Book value of liabilities
It excludes
The paid-up capital in respect of any equity shares, and the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general meeting of the company, and any type of reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards the depreciation, any amount representing any type of provision for taxation, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto, any amount representing provisions that are made for meeting liabilities, other than ascertained liabilities, any amount representing the contingent liabilities excluding arrears of dividends payable in respect of cumulative preference shares
Rule 11UA(2) of the rules are to be applied for valuation of Compulsory convertible preference shares (CCPS) along with the applicability of safe harbour threshold, which is provided to compute the FMV of CCPS on the valuation date.
Conclusion
The main purpose of Angel Tax's is to eliminate the inflow of black money through share premiums. Valuation becomes contentious during scrutiny assessments. Judicial precedents clarify various aspects, emphasizing adherence to legal interpretations and legislative intent. The Department must consider the nuances of each transaction to avoid misapplication of the provision.
The author can be contacted at aman.rajput@mail.ca.in in case of any queries
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