Valuation
Short answer
Rule 11UA of the Income-tax Rules prescribes how unquoted shares are valued for tax purposes. It matters most when an unlisted company issues shares above face value: if the issue price exceeds the fair market value determined under the rule, the excess can be taxed in the company's hands. The rule permits specified methods, including net asset value and, in prescribed cases, a discounted cash flow report from a merchant banker.
The problem the rule exists to solve
When an unlisted company issues shares at a price above their fair value, the tax law treats the excess as income of the company rather than as capital. The intent was anti-abuse — to stop unaccounted money being routed in as inflated share premium. The effect is that ordinary priced funding rounds have to be able to justify their price.
Rule 11UA is the machinery: it sets out how that fair value is computed, so a company can demonstrate that its issue price was supportable.
The methods
Broadly, the rule allows a net asset value approach and, for equity shares in prescribed circumstances, a discounted cash flow valuation reported by a merchant banker. Amendments in recent years have widened the permitted methods and added rules for non-resident investors, so the applicable set depends on the date and the investor.
For an early-stage company, NAV usually produces a value far below the round price, because the value is in the plan rather than the balance sheet. That is why DCF is the route most venture-backed companies take — and why the projections behind it get examined.
Where founders get caught
Three recurring problems, all avoidable:
- Commissioning the valuation after the round closes, so the price is already fixed and the report has to be reverse-engineered to it.
- Projections in the valuation that do not match the projections in the investor deck or the board-approved budget.
- Treating the tax valuation, the Companies Act valuation and the FEMA pricing certificate as three unrelated exercises, and ending up with three numbers.
How to do it properly
Commission the work before the term sheet hardens. Brief one team to produce a position that holds under the Income-tax Act, the Companies Act and — if any investor is non-resident — FEMA. Keep the assumptions documented and the underlying model available. Store the report with the secretarial records, because the next round's diligence will ask for it on day one.
This article is general information, current at the date shown, and is not advice on your specific facts. Tax and corporate law change, and thresholds and deadlines are amended regularly — check the position before you act on it, or ask us.
Where we help
Valuation Advisory
DCF, Rule 11UA, Registered Valuer and merchant-banker reports — one defensible number across Income Tax, Companies Act and FEMA.
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