Tag Archives: fair market value

Valuation for issuance of shares: Which method to choose?

Determining the fair market value (FMV) of unquoted shares may prove to be challenging for companies owing to choose the valuation method. There have been multiple rulings by the Income Tax Appellate Tribunal (the “ITAT”) wherein the methodology adopted by the company for the valuation has been rejected on the grounds of being non-substantial. However, few rulings have also been in favour of Companies where the ITAT has squashed the argument of the Assessing Officer (the “AO”) stating that the tax authorities can scrutinise the valuation report to the extent of finding any arithmetical mistakes and not compel a taxpayer to choose the method of valuation.

Despite Valuation practice being prevalent since the last six decades in India, there is no specific guidance on the same and the debate continues pertaining to the method to be followed.

Valuation Methods as per Rule 11UA of Income Tax Rules, 1962

As per Rule 11UA of Income Tax Rules, 1962, Companies have an option to adopt either the Net Asset Value (the “NAV”) method or the Discounted Free Cash Flow (the “DFCF”) method for valuation purpose. On 24 May 2018, the Central Board of Direct Taxes (CBDT) has amended the Income Tax Rules, 1962, by omitting the words “or an accountant” from rule 11UA(2)(b). As a consequence of such amendment, now only a merchant banker can independently determine the FMV of the unquoted equity shares by using the DFCF method and an accountant is no longer eligible to do this valuation.

Various Case Laws pertaining to the Valuation Methods opted by Companies

Case 1: In the case of M/s. TUV Rheinland NIFE Academy Pvt. Ltd., Vs. The Income Tax Officer, the Company had issued 5,00,000 shares having face value of INR 100 each, at a premium price of INR 479 per share, to its parent, TUV Rheinland (I) Pvt. Ltd. (“TUVR India”). The Fair Market Value (the “FMV”) of the shares was computed as Rs. 479 as per the DFCF Method which was based on the projections of the company’s future cash flows.

The Assessing Officer (the “AO”) rejected the valuation report on the grounds that the values were certified by the management of the taxpayer. Further, the AO computed the FMV based on the NAV and concluded that the FMV should be INR 84.20 per share. Hence, the AO passed an order wherein an addition of INR 19.74 crore was made to the taxpayer’s income. Such an addition was made under section 56(2)(viib) of the Income Tax Act, 1961.

The ITAT concluded that the AO had not rejected the choice of valuation method but the valuation entirely justifying that it was non-substantial and there is no proof given for the basis of estimates provided in the valuation. Further, the ITAT also mentioned that the actual figures did not have any relevance with the projections made. Thus, the arguments of the Company were rejected and reference was drawn from the ruling in Agro Portfolio Pvt. Ltd v. ITO wherein the AO can carry out its own independent valuation and adopt the NAV method for this purpose, after rejecting the original valuation by the Company.

Case 2: In the case of Innoviti Payment Solutions Pvt. Ltd. vs. ITO, the Company had issued 10,42,658 shares having face value of INR 10 per share at premium of INR 23.50 per share. The FMV was determined by a Chartered Accountant through the DFCF method.

The same was rejected by the AO mentioning that the accountant has taken haze cash flow as certified by the management and the projections were not verified by the valuer. Further, it also added that the company had failed to provide any basis for the projections and that the management had clearly ignored factors such as performance, growth prospects, earnings capacity, etc. The Bangalore Bench of the ITAT ruled that the projections made in the valuation report should be supported with reasonable certainty and in its absence the valuation report shall be deemed unworkable.

A similar contention was also drawn in the case of 2M Power Health Management Services Pvt. Ltd. vs. ITO.

Case 3: Contrary to the case 1 & case 2 above, the Bombay High Court in the case of Vodafone M Pesa Ltd. v PCIT, ruled that the AO do not have the authority to reject the method of valuation already adopted by the taxpayer. It justified that the AO has the power scrutinize the valuation report and point out any arithmetical error in the same, but not compel the taxpayer to choose an entirely different valuation method.

The Income Tax Rules, 1962 provides for an option to the taxpayer to choose either the DFCF or NAV method of valuation. Thus, the AO could not adopt a method of his choice, especially when Rule 11UA gives an option to the taxpayer to choose the method of valuation. Doing so, the it would render clause (b) of Rule 11UA(2) as purposeless.

The Jaipur Bench of the ITAT had drawn a similar ruling in the case of Rameshwaram Strong Glass Pvt. Ltd. vs. ITO and ACIT vs. Safe Decore Pvt. Ltd.

Concluding thoughts

Based on the various rulings, it can be concluded that the tax authorities do not have the power to order the taxpayer to adopt any particular method of valuation. The taxpayer has the right to choose the DFCF method or the NAV method for valuation as mentioned in the Income Tax Rules, 1962. However, it should be noted that the taxpayer should be able to provide reasonable information to substantiate the projections certified by the management. Since the valuation report shall be subject to scrutiny, the valuer should verify the parameters taken into consideration in preparation of the valuation report and should be in a position to justify the same.

Authors: Alivia Das and Shivani Handa


Basics of capital table and different capital instruments

The capital table is a reflection of the shareholding pattern of a company, shareholder names, percentage of shareholding.  This shareholding should ideally reflect the voting percentage in the company. But does it? What if the ESOP percentage has to be included while there is no voting on ESOP?

Founders should also consider the number of people on the capital table, though the maximum number in a private limited is 200, for various reasons including logistics of execution of documents, distribution of the annual accounts & annual report etc.

In this post, we have captured some of the key aspects to be considered while structuring the capital table.

At the time of Incorporation: It may be noted that the subscription of shares at the time of incorporation will be at face value and cannot be issued at a premium. The initial subscribers are usually the founders themselves.

The shareholding pattern amongst the founders is a function of many factors, such as roles and responsibilities and what each of them would bring to the table, whether investment is in cash or in terms of performance and service, for example, as a technical expert or a marketing expert. It certainly helps in decision making if one of the founders have majority shareholding. It is highly recommended that the founders enter into a founders’ agreement wherein the number of shares, percentage shareholding, future investment, vesting schedule, if any; roles and responsibilities of each founder, treatment of shares upon termination, etc. This would help in setting expectations as well as helpful in easing the founder terminations / resignations.

Employees Stock Option Pool (“ESOP”): A great team is instrumental and vital to the growth of an early stage company. However, the company may not have the finances to compensate with market salary to its employees at early stages (unless well funded). Thus, issuing stock options becomes very attractive – not only as compensation mechanism but also as building ownership and responsibility in the company. Stock options are notional unless they are exercised and shares are allotted. They represent a right to purchase a specified number of shares at a specific (exercise) price. When an employee exercises the Options and issued shares, then they became part owners in the company and can also sell the shares. Stock Options cannot be transferred or sold. Please see our previous post on Ten Frequently Asked Questions on Exercising Employee Stock Options in Private Limited Companies for more details in this regard.

Though Stock Options are not shares yet, it still forms a part of the capital table. External investments into the company, be it angel or institutional investment, are on a fully diluted basis. Ie. a shareholding pattern, as if all the outstanding share allotments regardless of vesting, assuming all stock options are converted, assuming all convertible securities are converted into common shares. Hence, Stock Options also form part of the capital table. In such a scenario, the percentage captured in the cap table is not necessarily the percentage of voting.

At the time of Investment: Whenever new investors subscribe to the shares of the company, the capital table undergoes a change. All the earlier shareholders’ percentage holding dilute, while the number of shares that they hold remains. If ESOP is set aside before the new investors coming in, then ESOP percentage dilutes, while the number of options set aside, remain the same.

Issuance to Advisors: Issuance of shares has to be at fair market value. Many a time, it is convenient for the founders to transfer their shares to the advisors. However, tax impact has to be evaluated for such transfers.

In India, we have different kinds of shares:
Equity share capital (common stock): (i) with voting (ii) with differential rights, such as dividend or voting. Founders typically have equity shares. ESOP is also typically granted as equity share class.

Preference share capital, which carry a preferential right over the equity shares to be paid dividend and a preference for repayment of capital in case of winding up. Investors typically have preference shares.

Preference shares can be:
Cumulative preference shares, which means that the holders are entitled to receive dividend even when a company does not make (adequate) profit, in which case the dividend is accumulated and paid when the company does have sufficient profits.
In Non-cumulative preference shares, the holders get the dividend only when a company makes sufficient profits, else the dividend lapses and cannot be carried forward.
Participating preference shares, means that the holders are eligible to receive surplus profits or dividends in addition to being entitled to their fixed dividend.
In Non-participating preference shares, the dividend paid is only to the extent of the agreed fixed dividend.
Convertible preference shares are those that are converted into equity within the maximum period of 20 years. Non-convertible preferences are those that do not get converted into equity shares.
Redeemable preference shares or optionally redeemable preference shares are those that have to be paid back within the maximum period of 20 years. We don’t have irredeemable preference shares.

The other form of investment is as debentures, which is primarily a debt. But the debt can convert into shares through the issuance of Compulsorily Convertible Debentures (CCD). You can read our post on CCD on the nuances related to its issuance. https://novojuris.com/2018/03/21/nuances-associated-with-issuance-of-compulsorily-convertible-debentures/

Investors also invest through CCD, especially when the valuation of the company is not clear. Here’s how it is done https://novojuris.com/2015/12/21/raising-of-funds-through-compulsorily-convertible-debentures/

You can share your thoughts or email your questions to relationships@novojuris.com

M & A: Different structures and a comparative

Acquisition of an entity can be undertaken in a number of ways such as an asset transfer, stock purchase, share swap, etc. It is critical to have certainty on the mode or structure of acquisition from the initial stage itself since the definitive agreements and the implementation steps for effectuating the acquisition will largely depend on the mode of acquisition. An acquisition transaction can be structured in different ways depending on the objective of the acquiring entity or the buyer. In this article, we have attempted to provide a brief overview and comparative of some of the different structures of acquisition.

Asset Purchase

  • In an asset purchase transaction, the acquiring entity takes over, either all or certain identified assets of the target entity or the seller. The first step in an asset purchase transaction is to determine what the assets and liabilities being taken over would be. Similarly, the definitive agreements should clearly lay down the assets/ liabilities being taken over and those which are not.
  • One of the major advantages of an asset purchase transaction is that the buyer can pick and choose the assets and liabilities which are to be acquired. The buyer may also choose not to take over any liabilities but purchase only the assets.
  • Another important aspect which has to be taken into consideration is with respect to the employees. In an asset transfer transaction, consent of the employees has to be taken if they are part of the acquisition transaction. Compliance to various labour laws has to be met. If the employees are not part of the transaction, then retrenchment compensation under Industrial Disputes Act, 1947 has to be examined. Please see our previous post on Employee Rights in M&A to know more on this.
  • In an asset purchase transaction, tax is calculated basis depreciable assets and non-depreciable assets. Capital gains tax is applicable basis the difference between the cost of acquisition and sale consideration. Depending on the holding period of the asset, either long term capital gains tax or short-term capital gains tax is applicable. In case of depreciable assets, depreciation is allowed as deduction.
  • Stamp duty is levied, in an asset purchase transaction, on the individual assets being transferred. Stamp duty is usually a percentage of the market value of the assets.
  • Losses or any other tax credits cannot be carried forward in an asset purchase transaction, as the target entity itself is not being acquired in this case. After an asset transfer, the shell entity remains and it is often a commercial consideration of whether the promoters of the acquired entity need to compulsorily shut down the shell entity or if it can be used for other business purposes. If the target entity continues to exist, considerations of ongoing business, usage of any remaining intellectual property, etc. become major discussion points between the parties involved.
  • Slump Sale: Slump sale refers to the sale of the entire business of an entity as a going concern without values being assigned to individual assets. As per section 2(42) of the Income Tax Act, 1961, ‘slump sale’ means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In case of a slump sale, the seller is liable to pay tax on the profits derived on the transfer at rates based on the period for which the undertaking is held. If the undertaking is held for more than 36 months, the capital gains will be taxed as long-term capital gains and if the undertaking is held for less than 36 months, capital gains will be taxed as short-term capital gains.

Share Purchase

  • Share purchase is a type of acquisition in which the buyer takes over the target entity by purchasing all the shares of such target entity. The entire liability of the seller is taken over by the buyer in such an acquisition.
  • An advantage of structuring an acquisition as a share purchase, is that there would not be any major disturbances caused to the business of the seller since there is no requirement of entering into fresh contracts, licenses, etc. Losses and other tax credits could also be carried forward.
  • If the shares being sold are held for more than 24 months, capital gains will be taxed as long-term capital gain tax. If the shares being sold are held for less than 24 months, the capital gains will be taxed as short-term capital gains tax. Indexation benefits will be as applicable.
  • In the event of transfer or issue of shares to a non-resident, the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 and the pricing guidelines have to be complied with.
  • Determination of fair market value pricing is important in such case, due to the applicability of pricing guidelines (in case of non-resident involvement) and also as per Section 50CA and Section 56(2)(x)(c) of the Income Tax Act, 1961, that provide for deeming provisions and taxation (in the hands of both transferor and transferee) basis full value consideration, in case of transaction price being less than FMV/full consideration.
  • Deferred Consideration: Since in a complete share purchase acquisition, the buyer also takes over the liabilities of the target entity, it is common to have deferred consideration models, in order to set off any future liabilities from the total consideration package. However, in case of such share purchase acquisition coming under the ambit of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, the Reserve Bank of India, vide Notification No. FEMA 3682016-RB, has mandated that not more than 25% of the total consideration can be paid by the buyer on a deferred basis within a period not exceeding 18 months from the date of the transfer agreement. As mentioned in the said Notification, for this purpose, if so agreed between the buyer and the seller, an escrow arrangement may be made between the buyer and the seller for an amount not more than 25% of the total consideration for a period not exceeding 18 months from the date of the transfer agreement, or, if the total consideration is paid by the buyer to the seller, the seller may furnish an indemnity for an amount not more than 25% per cent of the total consideration for a period not exceeding 18 months from the date of the payment of the full consideration.

However, this brings in difficulties in transactions where for commercial reasons, the buyer and the seller may mutually agree to tranche based or deferred consideration, which as per the mentioned Notification, can only done within certain specified parameters.


  • Another method of structuring an acquisition deal is through a share swap arrangement. In a share swap arrangement, if one entity wants to acquire another entity, instead of cash consideration, the shares of the buyer entity may be exchanged for the shares of the seller entity. An acquisition can be structured such that the entire consideration is through share swap or it can also be partly through share swap and partly through cash consideration.
  • If a foreign entity is involved in a share swap deal, the FDI and ODI Regulations become applicable. One of the most important consideration to be mindful of, is that the FDI regulations states that the price of shares offered should not be less than the fair market value of shares valued by SEBI registered Merchant Banker. Please refer to our previous post on M&A through Share Swap/Stock Swap Arrangements for more details in this regard.
  • The taxation in a share swap transaction works such that the shareholders swapping the shares are subject to taxation, basis the difference between the value of the shares being swapped. The concern here is that the shareholders will have to pay taxes when they have not received any actual cash consideration, but only shares of another entity by exchanging the existing shares they held.


  • In an acqui-hire transaction, typically, a relatively bigger entity, acquires the talent pool of a relatively smaller entity and this has gained significant prominence in the early stage ecosystem in India over the last couple of years. An acqui-hire may also be combined with an asset purchase transaction. The consideration in an acqui-hire is usually based on the talent of the employees, seniority, etc.
  • One of the main advantages of an acqui-hire transaction, from the perspective of the buyer, is that the employees already have experience, the buyer need not spend time, effort and energy in training them.
  • Another advantage of an acqui-hire is that the employees are usually subject to non-compete clauses with their employer and therefore, lateral hiring of employees may not be always possible especially when the acquirer is in a competing business as that of the target company. In an acqui-hire, the non-compete clauses would typically get waived.
  • Shares held by the existing investors of the target company and the way it is dealt varies on a case to case basis and it is mostly a function of discussion between the promoters, the existing investors and the potential buyer, given the economic condition and sustainability of the target company, if the acquisition does not go through.
  • Since the main objective of an acqui-hire is to acquire the employees, the employment agreement entered into with the acquired employees becomes very important. Adequate precaution needs to be taken to ensure that all important clauses such as earn out, non-compete, stock options granted to employees, etc. are included in the employment agreement.
  • Some of the consideration points of an acqui-hire deal would be conducting interviews of the employees selected to be acquired, and assess suitability. Also, there is always the possibility of the acquired employees leaving upon the expiry of the earn-out period, which then needs to be structured in a very balanced manner. This requires a very evaluated cost benefit analysis of the earn out versus the minimum time period for which an employee would be required to continue in the purchasing entity.

Cross-Border Merger

  • Cross-border mergers are one of the ways adopted by entities to expand their operations to a foreign country and entering into new markets. A cross-border acquisition means acquisition of one entity by a foreign entity.
  • Cross border mergers in India are mainly dealt with under the Companies Act, 2013 and the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Merger Regulations”). As per the Merger Regulations, the separate approval of RBI is no longer required as long as the cross-border merger is undertaken in accordance with the Merger Regulations.
  • Cross-border merger may be either ‘inbound merger’ or ‘outbound merger’. Inbound merger means a cross-border merger, where the resultant company is an Indian company. An outbound merger means a cross-border merger where the resultant company is a foreign company. A resultant company means an Indian company or a foreign company which takes over the assets and liabilities of the companies involved in the cross-border merger. There are separate set of compliances required for inbound merger and outbound merger under the Merger Regulations. For example, in case of an inbound merger, the compliances with respect to pricing guidelines, sectoral caps, reporting requirements, etc. under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 ought to be adhered to. Also, subject to the foreign exchange management regulations, the Indian entity is allowed to hold assets in the foreign country. Also, the Merger Regulations give both the Indian entities and foreign entities a time period of 2 years to comply with the foreign exchange management compliances. Please refer to our previous post on Cross-Border Mergers-Key Regulatory Aspects to Consider for further details regarding the regulatory aspects to be considered in case of cross border mergers.
  • One of the major concerns regarding cross-border mergers is with respect to taxation. While an inbound merger, where the resulting entity is an Indian company, is exempt from capital gains tax as per Section 47 (vi) of the Income Tax Act, 1961, there is no such exemption given in case of outbound mergers. Also, in case of outbound mergers, the branch office in India may be considered as a branch office of the foreign entity. In such a scenario, the branch office in India may be considered as a permanent establishment of the foreign entity in India and global income of the foreign entity may become be subject to tax in India.

Disclaimer: Structuring an M&A transaction is complex and requires a case to case evaluation of objectives, consideration, taxation at each stakeholder level, etc. The purpose of this article is to disseminate information only and readers are requested to seek profession advice shall for any individual requirement.

 We do not practice in tax matters. Any reference to tax matters herein is indicative and for reference purpose only.