Taxability of Excess Consideration Received on Shares Issued at a Premium

In India, any excess premium received by a company on shares is subject to taxation under the head of income from other sources. This taxation applies under specific conditions:

1. Issuing Shares in a Closely Held Company:

The excess premium taxation is applicable when shares (equity or preference shares) are issued by a closely held company. A closely held company is one where the public is not substantially interested.

2. Receipt of Consideration:

The excess premium taxation comes into effect when the consideration for issuing shares is received from any person, whether a resident or a non-resident.

3. Conditions for Exemption:

There are exemptions to this provision in specific cases:
Exemption applies when the consideration is received by a Venture Capital Undertaking from a Venture Capital Company, Venture Capital Fund, Category-I or Category-II Alternative Investment Fund (AIF).
Exemption also applies when the company is an eligible start-up fulfilling conditions as prescribed in Notification No. GSR 127 (E) [F.NO.5 (4)/2018-SI], Dated 19-2-2019.

4. Limit for Start-up Exemption:

To claim the exemption under Section 56(2)(viib), a start-up must ensure that the aggregate amount of paid-up share capital and share premium does not exceed Rs. 25 crores after the issuance or proposed issuance of shares.

5. Declaration Requirement for Start-ups:

Start-ups recognized by DPIIT (Department for Promotion of Industry and Internal Trade) need to file a declaration in Form 2 with DPIIT, along with details of the company, to claim the exemption. DPIIT forwards the self-declaration to the CBDT (Central Board of Direct Taxes) for approval.

6. Computation of Fair Market Value:

The fair market value of shares can be determined by:
Taking into consideration the suggestions received in this regard and detailed interactions held with stakeholders, Rule 11UA for valuation of shares for the purposes of section 56(2)(viib) of the Act has been modified vide notification no. 81/2023 dated 25th September, 2023.
The key highlights of the changes in Rule 11 UA are:
a) In addition to the two methods for valuation of shares, namely,

• Discounted Cash Flow (DCF) and
• Net Asset Value (NAV) method, available to residents under Rule 11UA,

Five more valuation methods have been made available for non-resident investors, namely,

• Comparable Company Multiple Method,
• Probability Weighted Expected Return Method,
• Option Pricing Method,
• Milestone Analysis Method,
• Replacement Cost Method.

b) Where any consideration is received for issue of shares from any non-resident entity notified by the Central Govt., the price of the equity shares corresponding to such consideration may be taken as the FMV of the equity shares for resident and non-resident investors, subject to the following:

• To the extent the consideration from such FMV does not exceed the aggregate consideration that is received from the notified entity, and
• The consideration has been received by the company from the notified entity within a period of ninety days before or after the date of issue of shares which are the subject matter of valuation.
• On similar lines, price matching for resident and non-resident investors would be available with reference to investment by Venture Capital Funds or Specified Funds.
• Valuation methods for calculating the FMV of Compulsorily Convertible Preference Shares(CCPS) have also been provided.
• A safe harbor of 10% variation in value has been provided.

The notified rule provides for expansion of the valuation methodologies to include globally accepted methodology and provide a broad parity to resident and non-resident investors.

7. Reporting and Penalties:

Failure to comply with these conditions may result in the consideration received from the issuance of shares exceeding the fair market value being deemed as the company's income and subject to taxation.
When the exemption is withdrawn, it's considered a misreporting of income, and a penalty is levied as per Section 270A.
In conclusion, understanding the taxability of excess consideration for shares issued at a premium involves careful consideration of specific conditions and compliance with the law. Both closely held companies and start-ups should be aware of these provisions and exemptions, as well as follow the appropriate methodology for determining the fair market value of shares. This knowledge ensures businesses can navigate the tax landscape with confidence and in compliance with the law.

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