Valuation Of Shares Under Income Tax Act

Valuation Of Shares Under Income Tax Act

Enterslice understands that capital shares are one of the most essential aspects of a business. We are fully equipped to provide expert services for the valuation of shares as per the Income Tax Act. Our valuation experts are well-versed in the process and the legalities involved in the procedures following the valuation of quotes or unquoted shares. Valuation is a significant procedure, and it is supposed to be done for key tasks like mergers and acquisitions, analyzing the market value of the business, investment analysis, etc. The government of India has come up with several rules and sets of instructions to complete the valuation process properly and without any false play. Enterslice's expert valuers understand the processes involved efficiently and strive to provide best-in-class valuation services per global and domestic norms. 

Overview of valuation of shares as per the Income Tax Act

Financial instruments are valued under different laws and regulations such as the Companies Act, Foreign Exchange Management Act, etc. One such act is the Income Tax Act. The Income Tax Act has laid many provisions for the valuation of shares and securities. It also lays emphasis on the importance of the fair market value in several provisions. Rule 11UA deals with the valuation of unquoted equity shares, as per clause (b) of sub-rule 2. According to the earlier, merchant bankers as well as a CA were able to do the valuation process, but as per the latest notifications and amendments, only a merchant banker is allowed to do the valuation of shares as per the Income Tax Act by using methods like discounted cash flow method.

Sections of the Income Tax Act for Valuation of Shares

• Rule 11UA (2)

  The provisions for calculating the fair market value of a security are listed in rule 11UA, and it also contains the various valuation methodologies that can be used to determine the fair market value of both quoted and unquoted shares.

• Section 56 (2) (vii)

  According to this section, when a private business gets any consideration for the issue of shares that exceeds the face worth of those shares, then the collected consideration received for those shares shall be taxable.

• Section 56 (2) (x) (c)

  The section applies to the individual receiving the shares and securities. In this, when a private business receives any consideration that is lesser than the face worth of those assets, then the difference between the FMV and the consideration shall be taxable.

Important Facets of Valuation of Shares as per the Income Tax Act 

• Fair Market Value

  Fair Market value (FMV) is the value a product would sell for on the open market, assuming both purchasers and retailer are level-headedly well-informed about the asset, are acting in their own best interest, are free of undue burden, and are given a practical time period for completing the transaction.

• Equity Shares

  If we remove all the preferential shares from a business, then what remains are the equity shares. They are also known as ordinary shares. If an individual holds equity shares of a company, then they're eligible to place their bets on the company's prospects and decisions.

• Quoted Shares

  Quoted shares are the shares that are listed on any recognized stock exchange. These kinds of shares are regularized on a timely basis, and the quotation placed on such shares is based on present transactions made in the day-to-day progression of the business. 

• Unquoted Shares

  Unquoted shares are the shares that are not listed on any stock exchange. The discounted flow method is recommended to calculate the fair market value of such shares. According to the latest amendments, a merchant banker is required to compute the valuation of such shares. 

Process of Valuation of Unquoted Shares 

• The provisions to calculate the valuation of quoted shares are laid in Section 56 (2) under clause (x) of the Income Tax Act. The CBDT has released rule 11UA with many amendments that provide provisions for the valuation of unquoted shares. The rule also laid down new provisions to calculate the fair market value of quoted shares.
• The Fair Market value of Unquoted Shares = (A+B+C+D-L) x PV/PE. Where A is the book value of all the assets as reduced by paid income tax and expenditure deferred by amortization, B is the fair market value of art and jewels, which is based on the valuation report compiled by a registered valuer, C is the fair market value of shares and securities established as per the rule, D is the stamp duty valuation as per any immovable property, L is the book value of liabilities which excludes paid up equity share capital, the amount set apart for unquoted dividend, surplus and reserves, requirements for tax, provisions for unsure liabilities and conditional liabilities. 
• PV is the paid-up value of an equity share, and PE is the aggregated amount of paid-up equity shares mentioned in the balance sheet.
• According to the amendments in e rule 11UAA, the fair market value of the share of a company, apart from quoted shares, will be established according to the provisions given in rule 11UA (1) (c) (b)/(c).
• The amendments in rule 11UAA also laid down rules to select the valuation date. The valuation date is supposed to be the date on which those shares are transferred.
• As per the Income Tax Act, only a registered valuer or a merchant banker registered with appropriate regulations is supposed to evaluate the fair market value of shares.

CBDT’s Final Rules for Valuation of Unquoted Shares 

• Valuation of Compulsory Convertible Preference Shares

  A new amendment has been made to calculate the fair market value of CCPS, and the value is supposed to be determined on the basis of consideration received from a resident or a non-resident. Based on the fair market value of unquoted shares as per clause (a), (b), (c), (d), or (e). The rule also reflects that the safe harbour threshold, as per Rule 11UA, will also be applicable to establish the fair market value of CCPS (Compulsory Convertible Preference Shares). The rule also defines the ‘issue price’ as the consideration received by the entity for a single share.

• Valuation according to the clause (c) and (e)

  According to clauses (c) and (e) of rule 11UA, the issue price is analogous to considerations received by some entity for the purpose of issuing shares from a specific notified entity within a timeframe of 90 days after or before the shares were issued, which are subjected to be valued, is the fair market value of those shares. The entity can be a venture capital company, a specified fund, or a venture capital fund. The fair market value must not exceed the collected consideration procured from such an entity. 

• Rules to Determine the Valuation Date

  Rule 11UA (3) produced objective rules that state that the date of valuation report by a merchant banker must not exceed more than 90 days prior to the date of issuance of shares that are subjected to valuation. The taxpayers can deem this date as the date of valuation. Rule 11UA (3) also states that in such a situation, the rules written in the Rule 11U (j) will not be applicable. The rule has come into effect from the date the notice was issued from the official gazette.

Understanding the facets of section 50 CA of the Income Tax Act 

Before introducing section 50 CA, where the shares were sold by the individual who’s assessing for consideration, which is not as per the fair market value of those shares, there was no methodology available in accordance with the act to replace the full value of considerations that is reflected by the assessor in the form of any other value in order to calculate the capital gains. Section 50 C only dealt with provisions for the transfer of capital assets like buildings, land, or both, which is not correct for the case of shares. In order to bridge this gap, section 50CA was introduced. This section is applicable to every assessor, whether they're residents or non-residents or are from an unrelated entity. The rule is also applicable to all preference and equity shares. The rule is not applicable to the gains attained from the transfer of an interest in a partnership trust, where the properties of such organizations consist of immovable properties, directly or indirectly. According to the new formula method, the fair market value shall be taken as the full value of the consideration, even in cases where the difference between fair market value and sales consideration is negligible.

Need for Valuation of Shares 

The valuation of shares is required for many objectives, some of which are listed below-

• Selling a Business

  While deciding on or contemplating a business’s sale, it’s crucial to know the actual and correct value of shares. The valuation of these shares acts as the benchmark for negotiations. It enables business owners to ensure that they have received appropriate compensation.

• Mergers and Acquisitions

  Valuation plays a key role in any corporate deal. Establishing the share’s worth aids in evaluating the transaction’s economic durability. It also aids in assessing probable synergies during the process of mergers and acquisitions of new ventures.

• Initial Public Offering (IPO)

  The valuation of shares holds particular importance when a private business decides to go public. A thorough evaluation of the business’s value lets the stakeholders place precise pricing on shares for the IPO. This process helps a business attract more investors.

• Benefits of Investors

  Prudent investors rely on share appraisal to make informed and beneficial investment choices. Evaluating the share value helps an investor identify any probable growth prospects, future returns expected, and risks. This process also enables them to consider other investment options.

• Compliance and Financial Reporting

  Shares are vital for financial reporting objectives of valuation. The process inculcates annual reports, regulatory compliance, and audits. It precisely reflects the business’s financial standings and aids in meeting legal requirements.

• Estate Planning and Taxation

  Share valuation establishes tax loopholes and liabilities and evaluates share value for the purpose of estate planning. It helps tactical decision-making and fruitful asset management by minimizing tax liabilities.

• Inbound Decision- Making

  When talking about the inner workings of a business, share valuation is crucial for internal processes of decision-making. It provides key insights into the business's performance, potential for growth, and domains where improvement is required. It acts as a bridge of understanding between individuals and businesses in complex financial environments. It helps investors make prudent choices and navigate hurdles efficiently.

Future Cash Flow Method for Valuation of Shares (Reference: REVENUE STAGE)

The future cash flow method is a method to evaluate the fair market value of shares. It determines the expected cash flows over a particular period of time. It is one of the most commonly used methods to determine the valuation of shares. The method is heavily dependent on the financial streams and projections of a business. In this, the time value of money is considered, and it also discounts future cash flows to their current value. The most crucial task for this method is the application of a suitable discount rate. The discount rates are important as they reflect the risk and opportunity price of investment. Investors use this method to establish the intrinsic value of the shares.

Net Asset Method for Valuation of Shares (Reference: GROWTH STAGE)

The net asset method of valuation is used to evaluate the shares with respect to the business’s net assets. These net assets include both tangible and intangible assets. The tangible assets are- inventory, properties, equipment, etc. Intangible assets are – brand value, IPR, trademarks, patents, etc. In order to determine the net asset value (NAV) of a business, a person has to subtract all the liabilities from these net assets. This technique is particularly beneficial for businesses with a considerable amount of assets, such as manufacturers, real estate, etc. This method provides the intrinsic value of the business with respect to its assets.

Other Widely Used Techniques for Valuation of Shares (Reference: Financial Reporting Services)

• Discounted Cash Flow Method

  The discounted cash flow method for the valuation of shares is important for projected cash flows. This method includes estimating future cash streams and discounting them to their current value. The discount rate shows the business’s risk potential and the scope of investment cost. This method takes into account the risk degree, growth potential, and the cost of capital. It comprehensively evaluates the intrinsic value of the shares. Many investors and stakeholders use this method to analyze a business’s cash stream generation prospects.

• Market Price Method

  The market price method evaluates the shares with respect to their present market price. It is dependent on the fundamentals of supply and demand and represents the aggregate opinion of market contenders. It is among the most widely and commonly used methods for valuation of shares. Market prices are usually affected by factors like industry volatility, business performance, economic standing, and market trends. Investors compare valuation aspects like the P/E ratio or industry standards to the market price. They use this metric to evaluate the share's performance.

• Comparable Company Analysis

  This method of valuation of shares involves comparing the business with its competitors in the market from the same domain. The method determines the valuation by comparing metrics like the P/E proportion, EV/EBITDA, and price-to-sale ratio. These key metrics are utilized to determine the fair value of shares. This methodology gives relative valuation observations. The investors can evaluate the shares and can contemplate whether they're overvalued or undervalued compared to other businesses in the same domain. In all, this method also enables an investor to make prudent investment choices.

Enterslice’s Share Valuation Services 

• Fairness Opinion

  A report discussing the purchase or sale of assets or company interests is usually given to a board of directors in order to obtain a fair opinion. The fairness view is typically taken into consideration by the board of directors when making decisions about whether to move forward with or finish a transaction. Our valuation experts are well-versed in the concepts involved in calculating the Fair Market Value of shares.

• Registered Valuer

  Registered valuers are also referred to as Private valuers. They are accredited by the board and are necessary papered by the Income Tax department. They work in a private capacity, and their valuation is not obligatory on the tax authorities, but the assessing officer cannot disregard such valuation unless he has consulted the departmental valuation officer for valuation. Enterslice is fully equipped to provide valuation reports with the help of a registered valuer associated with us.

• Equity Valuation

  Equity Valuation is a cardinal process for investors looking to make well-thought-out decisions in the stock market. It entails determining the intrinsic or fundamental value of a company’s stake to evaluate whether they are undervalued, overvalued, or fairly priced. It is a course of accessing the value of a company’s stock by scrutinizing its financial declarations, operational presentation, future business trends, and economic circumstances. Enterslice is fully equipped to provide top-notch equity valuation services for all your business needs.

Other Crucial Services for Valuation of Shares

• Transaction Advisory

  Enterslice’s valuation advisors analyze the historical performance but also use this information to determine if the projections are based on reality. Our advisors provide full support throughout the full life cycle of a transaction. 

• Impairment Test

  The impairment test done by our valuation advisors will provide investors and analysts with multiple ways to assess a company’s administration and decision-making track record. Managers who write off assets due to impairment may not have made a worthy investment decision before initiation.  

• Compliance

  It is important for businesses to practice all the activities under the law. The business needs to stay legal to do any business. Our valuation advisors will help a company by assisting with the necessary compliance due diligence.

• Risk Analysis

  Every business has a potential risk in the market. Our valuation advisors will help a company identify any risks that may come a company’s way with the potential of hindering the workings of the particular company.

Enterslice’s Road to Success 

Enterslice is one of the most highly regarded valuation firms in the county, known for its impartiality, technical proficiency, and independence. Our expert valuers are part of an international team of valuers, where they share understandings and competence to aid effortless work across channels. Enterslice’s in-depth financial, analytical, and economic proficiency has helped clients with better decision-making for over 10+ years. Our valuers are registered with appropriate regulatory authorities, hence giving you 100% satisfaction. 

Enterslice’s Resolve to Brilliance

• Maximum Gratification

  Client Satisfaction has always been our no. 1 priority. When it comes to valuation, our competent valuers leave no stone unturned to gather all the aspects of the asset in order to give 100% accurate valuation figures.

• Recurring Improvement

  One of the core values of Enterslice is the belief in constantly working and evolving our services to stay on top and ahead of the bunch. Our team stays up to date with the latest trends and methodologies prevailing in the market.

• Quality Assistance

  Our team at Enterslice is highly output-driven and works to provide best-in-class services to our clients. We make sure that all your business needs are fulfilled.

Advantages of Hiring Enterslice’s Valuation Experts 

Strong business proprietors pour a lot of blood, sweat, and tears into their businesses. They work hard to make a living for themselves and their employees, but they often don’t have a sense of the bigger market picture. There are many convincing reasons to hire a specialized valuation advisor. If you know the worth of your assets, you can identify the businesses’ least selling price needed to make a profit. A professional valuation of your business resources can help identify how much insurance coverage you need and set reinvestment objectives. Professional valuation advisors will help you create a current benchmark for your company’s value. Thus, when you get another valuation in the future, you can see how your company has grown and performed.

Risks of not hiring a Valuation Service Provider 

There are several risks involved with not hiring a valuation advisor, some of which are- The technique used by a business valuer for a business valuation will have a direct impact on the valuation report. At Enterslice, our valuation experts practice different and appropriate valuation techniques. If a business valuer does not have access to comparable statistics on sales data of comparable companies, then there is a high chance that the valuation they did could be wrong. An incompetent business valuer may not have appropriate knowledge of the business valuation process. A valuation advisor will help guide a business towards the correct approach to solving any problems within its features.