The Income Tax Act’s announced Rule 11 UA went into force on September 25, 2023. This has resulted in extensive changes being made to the way unlisted equity shares are valued. These modifications provide taxpayers with many options for determining valuation, including using a strategy that is widely accepted across the world. This will boost tax transparency and draw in foreign investment. Startups will be better able to attract financing from international investors if they provide a variety of valuation and pricing choices.

For unlisted firms, the Central Board of Direct Taxes (CBDT) has further loosened angel tax regulations. The 10% safe harbor, which was previously solely available to equity shares, has now been extended by the CBDT to convertible preference shares. When describing the valuation guidelines for investments in unlisted companies by domestic and international investors under the Angel Tax included in the Finance Act 2023, CBDT created this provision.

The final regulations and significant revisions to the rules are now in force as of September 25, 2023. Since convertible preference shares have been used for the majority of investments in recent years, startups should benefit greatly from this.

According to the revised regulations, businesses may now raise financing through equities and mandatorily convertible preference shares up to a certain maximum (10% of the shares’ fair market value). Such investments won’t be subject to AIG tax if they comply with the safe harbor clauses described above. Even if there was a slight valuation difference, there used to be a provision for angel tax. The discrepancy between equity and convertible preference shares is currently seen by the government as acceptable up to 10%.

The draft valuation standards released by the CBDT on May 19 had drawn criticism from the majority of businesses. They feared that it would have an impact on their international investments. Several concessions, including a safe harbor for convertible preference shares, had been requested by startup enterprises.

Convertible preference shares account for around $20 billion of the estimated startup investments made by the market. When a business generates money by selling investors shares at a price over the fair market value, an angel tax is assessed. On net investments that are worth more than their fair market value, this tax is levied at a rate of 30.9%.

Previously, only investments made by domestic investors were subject to the angel tax. However, a provision in the Finance Act 2023 has been made to include non-resident investors in its scope as of April 1, 2024.