Advisory- Valuation of Shares

Income Tax Act, 1961 read with rules made thereunder Companies Act, 2013 read with Companies (Share Capital & Debentures) Rules Foreign Exchange Management Act, 1999 and related RBI Regulations

Discussions:

Issue 1: Preferred mode of the further issue of shares, i.e. right issue or private placement?The further issue of shares is suggested to be done through rights issue due to the following benefits under Companies Act, 2013:
a. Private Placement is time consuming since the notices for General Meeting and consequent sending of offer letters to investors, their approvals/ rejection is required. Private Placement is more preferred when there is larger number (maximum 200) of intended investors and the share capital is staggered and in part payments/ tranches. Rights issue is quick and only existing shareholders are involved. In our case, the number of existing shareholders and proposed investors are minimal and shareholders are willing to renounce their right to proposed investors. Hence, rights issue is more preferred in the instant case.
b. There is no right issue share valuation requirement under Companies Act, 2013 vis a vis private placement where shares are separately required to be valued.c. No separate bank account for receipt of share capital tranches is required in rights issue. The share capital can be instantly put to use after it has been received in the Bank account of the Company.
Issue 2: Whether there is any requirement for valuation of shares in the case of further issue of shares by the company in the form of right issue and its renunciation thereof to foreign investor?
Relevant Clauses:Income Tax Act Clause (viib) of sub-section (2) of section 56 of the Income Tax Act, 1961 states:“ where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares….”

For the purpose of this clause fair market value is determined in accordance with the method laid down under Sub-Rule (2) of Rule 11UA of the Income Tax Rules, 1962.

The above clause requires valuation of shares of private company in case of further issue when shares are issued above its face value (irrespective of the mode of issue of shares i.e. whether private placement, preferential allotment or right issue). This provision is applicable when shares are issued to residents. However, in the instant case, the shares shall finally be issued to non-resident through renunciation. Hence, the instant case is outside the ambit of valuation clause of Income Tax Act, 1961.Companies Act sub-section (1) of Section 62 of the Companies Act contains the provision related to further issue of share capital as right issue. The relevant extract is as follows:Section 62(1) “Where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares; such shares shall be offered—
(a) to persons who, at the date of the offer, are holders of equity shares of the company in proportion, as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer subject to the following conditions
(i) the offer shall be made by notice specifying the number of shares offered and limiting a time not being less than fifteen days and not exceeding thirty days from the date of the offer within which the offer, if not accepted, shall be deemed to have been declined;]
(ii) unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of any other person; and the notice referred to in clause (i) shall contain a statement of this right;
(iii) after the expiry of the time specified in the notice aforesaid, or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered, the Board of Directors may dispose of them in such manner which is not dis-advantageous to the shareholders and the company……….”

Valuation of shares by registered valuer is needed in case of further issue of shares through private placement (Section 42) or preferential allotment (Section 62(1)(c)). However, in case of right issue the above-mentioned section does not refer to valuation of right shares.

There is no rule prescribed under the Companies Act, 2013 that contains the procedure & conditions related to issue of right share or the related valuation and renunciation. The issue of right shares, though, is subject to provisions contained in Articles of XXXX Private Limited. We have studied the articles of company; the articles are silent on the issue of right shares, its valuation and renunciation. Thus, there is no valuation requirement under Companies Act, 2013.

Foreign Exchange Management Act:

Central government by notification dated 17th Oct, 2019 prescribed the Foreign Exchange Management (Non-debt instrument) Rules, 2019 that prescribe the provisions related to investment made by non-resident in India in the non-debt instrument.Rule 7 of the above rules contains the conditions for Acquisition through rights issue or bonus issue by a non-resident which is read as under: “A person resident outside India and having investment in an Indian company may make investment in equity instruments (other than share warrants) issued by such company as a rights issue or a bonus issue, provided that,-
(a) the offer made by the Indian company is in compliance with the provisions of the Companies Act, 2013;
(b) such issue shall not result in a breach of the sectoral cap applicable to the company;
(c) the shareholding on the basis of which the rights issue or the bonus issue has been made must have been acquired and held as per the provisions of these rules;
(d) in case of a listed Indian company, the rights issue to persons resident outside India shall be at a price determined by the company;
(e) in case of an unlisted Indian company, the rights issue to persons resident outside India shall not be at a price less than the price offered to persons resident in India;
(f) such investment made through rights issue or bonus issue shall be subject to the conditions as are applicable at the time of such issue;
(g) the mode of payment and attendant conditions for such transactions shall be specified by the Reserve Bank.
(h) an individual who is a person resident outside India exercising a right which was issued when he or she was a person resident in India shall hold the equity instruments (other than share warrants) so acquired on exercising the option on a non-repatriation basis.

Explanation: The above conditions shall also be applicable in case a person resident outside India makes investment in equity instruments (other than share warrants) issued by an Indian company as a rights issue that are renounced by the person to whom it was offered.” Sub-rule (2) of Rule 22 of above Rules prescribes the pricing guidelines for issue of securities to non-residents. The relevant extract is as follows:“Unless otherwise prescribed in these rules, the price of equity instruments of an Indian company, –
(a) issued by such company to a person resident outside India shall not be less than :
(i) the price worked out in accordance with the Securities and Exchange Board of India guidelines in case of a listed Indian company or in case of a company going through a delisting process as per the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009;
(ii) the valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practicing Cost Accountant, in case of an unlisted Indian Company. …………….”

From the reading of above rule it is concluded that the valuation of shares is needed in case of issue of shares to person resident outside India as per the provision of Foreign Exchange Management Act. In the instant case, though the shareholders entitled for right shares are resident in India however, they are going to renounce their shares to person resident outside India. Therefore the above mentioned valuation as per Foreign Exchange Management (Non-debt instrument) Rules, 2019 is required to be done as shares are going to be eventually issued to person’s resident outside India. The persons authorized to do valuation is a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India.

Conclusion:

In the given case, It is suggested to issue shares under rights issue mechanism as suggested under Companies Act, 2013.There is no requirement to value right issue of shares on issue or renunciation as per the provision of Income Tax Act, 1961 & Companies Act, 2013. However, in the present case the right shares shall eventually be renounced to non-residents, therefore, due to the applicability of Foreign Exchange Management Act, 1999 and rules made thereunder the valuation of shares on further issue as right shares by practicing chartered accountant or merchant banker registered with SEBI is required.