In the business world, the rearview mirror is

always clearer than the windshield

Warren Buffett

Due Diligence, Legal and

Regulatory Valuation aspects

Valuation in Indian Regulatory

Environment
Dated: 30th April, 2014

Contents

Particulars

Pg. No.

Part A

Overview of Valuation

Part - B
Valuation in Indian Regulatory Environment

13

Part - C
Registered Valuer

51

Part - D
Tricky Issues

54

Part A

Overview of
Valuation

Value & Valuation

Value is*

An Economic concept;

An Estimate of likely prices to be concluded by the buyer and seller of a good or

service that is available for purchase;

Not a fact.

Valuation is the process of determining the Economic Worth of an Asset or

Company under certain assumptions and limiting conditions and subject to the
data available on the valuation date.
* Source -International Valuation Standard Council

Economics of Valuation
Valuation across business cycle follow the law of
economics
Turnover/Profits: Drops

Declining
Cos.

Turnover / Profits

Mature
Cos.

High Growth
Cos.

Growing
Cos.

Start Up
Cos.

Proven Track Record: Substantial

Operating History
Method of Valuation: Entirely
from Existing Assets
Cost of Capital: N.A.

Turnover/Profits: Saturated
Proven Track Record: Widely Available
Method of Valuation: More from Existing Assets
Cost of Capital: May be High

Turnover/Profits : Good
Proven Track Record: Available
Valuation Methodology: Business Model with Asset Base
Cost of Capital: Reasonable

Turnover/Profits: Increasing still Low

Proven Track Record: Limited
Valuation Methodology: Substantially on Business Model
Cost of Capital: Quite High

Turnover/Profits: Negligible
Proven Track Record: None
Valuation Methodology: Entirely on Business Model
Cost of Capital: Very High

Time

Intangibles

Equity#
Net Current
Assets

Net

Debt#

Stakeholders
# Based on Market Values

Fixed
Assets

Assets

Value of Business

Enterprise Value

Enterprise / Business Value

Valuation Approaches
Fundamental Method
Income Based
Method
Capitalization of
Earning Method
(Historical)

Discounted Cash
Flow Method
(Projected

Relative Method
Other Method

Asset Based
Method

Market Based
Method

Book Value Method

Comparable
Companies Market
Multiples Method
(Listed Peers)

Contingent Claim
Valuation
(Option Pricing)

Liquidation Value
Method

Comparable
Transaction Multiples
Method
(Unlisted Peers)

Price of Recent
Investment Method

Replacement Value
Method

Market Value Method

(For Quoted
Securities)

Time Value)

Rule of Thumb
(Multiples:
Customers, Rooms,
Seats, No. of visitors
etc.) - Depends
upon Industry

Key drivers of valuation

CASH FLOW
Investor assign value based on the cash flow they expect to receive in the
future
Thats why DCF is most
- Dividends / distributions
- Sale of liquidation proceeds

Value of a cash flow stream is a function of

- Timing of cash Receipt

prominent

valuation

method

- Risk associated with the cashflow

ASSETS
Operating Assets
- Assets used in the operation of the business including working capital, Property, Plant &
Equipment & Intangible assets
- Valuing of operating assets is generally reflected in the cash flow generated by the
business

Non - Operating Assets

- Assets not used in the operations including excess cash balances, and assets held for
investment purposes, such as vacant land & Securities
- Investors generally do not give much value to such assets and Structure modification
may be necessary

Need for Restructuring

Valuation depends upon

Purpose
Mergers
IPO
Acquisitions /
Investment
Voluntary
Assessment

Regulatory

Accounting

RBI

ESOP

Income Tax

Purchase Price
Allocation

SEBI

Impairment /
Stock Exchange Diminution
Companies Act

Dispute
Resolution

Value
Creation

Company Law Equity Research

Board/ Courts
Credit Rating
Arbitration
Corporate
Mediation

Planning

Choice of Valuation Approaches

Value in Valuation is a question,
and
Your choice of Method is the first step
towards answer
Applicability of a particular approach depends upon:
On whose behalf? one buyer vs another buyer, buyer vs seller;
For what purpose? independent strategic acquisition, group company consolidation, cross
border transaction;
When? distress situation, industry downturn, boom etc;

Choice of Valuation Approaches

In General, Income Approach is preferred;

The dominance of profits for valuation of share was emphasised in McCathies case (Taxation,

69 CLR 1) where it was said that the real value of shares in a company will depend more on the
profits which the company has been making and should be capable of making, having regard to
the nature of its business, than upon the amount which the shares would realise on liquidation.
This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalans
case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.)
(122 ITR 38).

However, Asset Approach is preferred in case of Asset heavy companies

and on liquidation;
Market Approach is preferred in case of listed entity and to evaluate the
value of unlisted company by comparing it with its listed peers;

Rule of Thumb
A rule of thumb or benchmark indicator is used as a
reasonableness check against the values determined by the
use of other valuation approaches.
Industry

Valuation Parameters

Hospital

EV/Room

Engineering

Mcap/Order Book

Mutual Fund

Asset under management

OIL

EV/ Barrel of equivalent

Print Media

EV/Subscriber

Power

EV/MW, EBITDA/Per Unit

Entertainment & Media

EV/Per screen

Metals

EBITDA/Ton, EV/Metric ton

Textiles

EBITDA depend upon capacity utilization Percentage & per spindle value

Pharma Bulk Drugs

New Drug Approvals , Patents

Airlines

EV/Plane or EV/passenger

Shipping

EV/Order Book, Mcap/Order Book

Cement

EV/Per ton & EBITDA/Per ton

Banks

Non performing Assets , Current Account & Saving Account per Branch

However, Exclusive use of Rule of Thumb is not recommended

Part B
Valuation in Indian Regulatory Environment

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Transactions

Reserve
Bank of
India

Prescribed Methodologies

Mandate to be done by

Inbound Investment

DFCF

CA / MB

Buy back of Equity

shares/ CCPs/ CCDs of
listed co. issued under
FDI policy

Market price prevailing at

recognized stock exchange

Buy back of Equity shares

of unlisted co. issued
under FDI policy

ROE as per latest Audited

Balance Sheet

Buy back of CCP / CCD of

unlisted co. issued under
FDI policy

Pricing as per internationally

accepted pricing methodology

CA / MB

Valuer Discretion

>5Mn$ - MB, otherwise CA/MB

Outbound Investment

Old

Inbound Investment
Buy back of Equity
shares/ CCPs/ CCDs of
listed co. issued under
FDI policy
Buy back of Equity shares
of unlisted co. issued
under FDI policy
Buy back of CCP / CCD of
unlisted co. issued under
FDI policy
Outbound Investment

Acceptable market
practices. Operating
guidelines will be notified
separately

Yet to prescribe

New

Income Tax

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Analysis of Applicability of Section - 56 of Income Tax Act, 1961

Particulars

56(2)(vii)

56(2)(vii)(a)

56(2)(vii)(b)

Allotment / Issue of Shares

Transfer of Shares
Resident
Non Resident
NAV Method

Minimum Value

Maximum Value
DCF Method
Recipient
Issuer

Capital Asset

Valuer

Exemptions

Individual / HUF

Firm / Closely held Company

Any Person being resident of India

Any Person

Any Person

Closely held Company

Property (Shares /
Securities etc), Sum of
money

Property except shares of

Widely held Company

Shares

SEBI registered category I MB, PCA

SEBI Registered Category I MB, FCA

Payer is any relative/ on

Transactions which are not regarded
occasion of marriage/
as transfer under Clause (via) or (vic)
inheritance/ from any trust or (vicb) or (vid) or (vii) of Section 47
/ local authorities.
of Income Tax Act, 1961

Venture Capital Company, Venture Capital

Fund, Venture Capital Undertaking

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Transactions

Prescribed Methodologies

ESOP Tax

Valuer Discretion

MB

Arm Length Price

Mandate to be done by

Income
Tax
Transfer Pricing

ESOP Accounting

SEBI

Option Pricing Model

Takeover Code/ Delisting Infrequently Traded

Only Parameters Prescribed

Return on Net Worth, EPS,
NAV vis-a vis Industry
Average

PCA/MB

Takeover Code/ Delisting Frequently Traded

Based on Market Price

Notification:
94/2009 of
CBDT

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Transactions

Prescribed Methodologies

Mandate to be done by

Preferential Allotment to
Others

Based on 26 weeks / 2 weeks

Market Price

Preferential Allotment to
promoters / their relatives
for consideration other than
cash

Valuer Discretion

CA / MB

Companies
Act, 1956

Sweat Equity

Valuer Discretion

Companies
Act, 2013

any property, stock, shares,

debentures, securities or
goodwill or any other assets
or the net worth of the
Company or its liabilities

Stock
Exchanges

To be prescribed

REGISTERED VALUER

RBI Valuation Guidelines

FDI
VALUATION
Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals

with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside
India) Regulations, 2000.
In terms of Schedule 1 of the Notification, an Indian company may issue equity
shares/compulsorily convertible preference shares and compulsorily convertible debentures

(equity instruments) to a person resident outside India under the FDI policy, subject to inter alia,
compliance with the pricing guidelines.
The price/ conversion formula of convertible capital instruments should be determined upfront
at the time of issue of the instruments.

FEMA Guidelines to Valuation

Particulars

Valuation before April 21, 2010

Guidelines in Force

CCI Guidelines

Methods Prescribed

Net Assets Value (NAV)

Profit Earning Capacity
Value(PECV)
Market Value (in case of Listed
Company)

Valuation after April 21, 2010

In case of FDI Transactions:
Listed Company: Market Value
as per SEBI Preferential
Allotment Guidelines
Unlisted Company: DFCF
In case of ODI Transactions:
No method has been prescribed

Discount

15% Discount has been

prescribed on account of Lack of
Marketability

No such Discount has been

prescribed

Historical / Futuristic

It is based on Historical Values

It is based on Future Projections

Possibility of variation As valuation is more Formulae

in Value Conclusion
based, final values came
standardized

As valuation is more dependent

on Assumptions and choice of
factors like Growth Rate, Cost
of Capital etc, value conclusion
may vary significantly.

Note: Valuation guidelines do not apply to SEBI registered venture capital

Approaches to FDI Valuation

Discounted Free Cash Flow Method (DFCF)
RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for
initial subscription); but has not provided any guidance on its technical aspects.
Though DFCF is one of the most acceptable Valuation methods used by Business
valuers worldwide; however DFCF for all FDI transactions-excluding for initial

subscription (like minority stake/start up valuation etc) may not yield Fair Value in
line with the Commercial understanding. However Law being such, suitable Logical
adjustments may be necessary on a case to case basis.

DFCF expresses the present value of the business as a function of its

future cash earnings capacity. In this method, the appraiser estimates the
cash flows of any business after all operating expenses, taxes, and necessary
investments in working capital and capital expenditure is being met. Valuing
equity using the free cash flow to stockholders requires estimating only free
cash flow to equity holders, after debt holders have been paid off.

Major Characteristics of DFCF Valuation

Forward Looking and focuses on cash generation

Recognizes Time value of Money
Allows operating strategy to be built into a model

Incorporates value of Tangible and Intangible assets

Only as accurate as assumptions and projections used
Works best in producing a range of likely values
It Represents the Control Value

DFCF Valuation Process

Understand Business Model

Identify Business Cycle
Analyze Historical Financial Performance
Review Industry and Regulatory Trends
Understand Future Growth Plans (including Capex needs)
Segregate Business and Other Cash Generating Assets

Identify Surplus Assets (assets not utilized for Business say

Land/Investments)
Create Business Projections (Profitability statement and Balance Sheets)
Discount Business Projections to Present (Explicit Period and Perpetuity)
Add Value of Surplus Assets and Subtract Value of Contingent Liabilities

Free Cash Flows- Value Trend

Terminal Value is calculated for the Perpetuity period based on the

Adjusted last year cash flows of the Projected period.

Free Cash Flow calculation

FREE CASH FLOWS

Free cash flows to firm (FCFF) is calculated as
Taxes
EBITDA

Change in Non Cash Working capital

Capital Expenditure

Free Cash
Flow to
Firm

Note that an alternate to above is following (FCFE) method in which the

value of Equity is directly valued in lieu of the value of Firm. Under this
approach, the Interest and Finance charges is also deducted to arrive at the
Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows)
over the definite period of Cash Flows and also in Perpetuity workings.
Theoretically, the value conclusion should remain same irrespective of the
method followed (FCFF or FCFE), (Provided, assumptions are consistent).

Cost of Capital calculation

DISCOUNT RATE WEIGHTED AVERAGE COST OF CAPITAL
(Kd x D) + (Ke x E)
WACC

(D + E)

Where:
D = Debt part of capital structure
E = Equity part of capital structure
Kd = Cost of Debt (Post tax)
Ke = Cost of Equity

In case of following FCFE, Discount Rate is Ke and Not WACC

Cost of Equity calculation

DISCOUNT RATE - COST OF EQUITY
The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing
Model (Mod. CAPM)
Mod. CAPM Model
ke = Rf + B ( Rm-Rf) + SCRP + CSRP

Where:
Rf =
Yield)
B =
Ke =
Rm=
of

Risk free rate of return (Generally taken as 10-year Government Bond

Beta Value (Sensitivity of the stock returns to market returns)
Cost of Equity
Market Rate of Return (Generally taken as Long Term average return

Stock Market)
SCRP = Small Company Risk Premium
CSRP= Company specific Risk premium

Terminal value calculation

PERPETUITY FORMULA
Usually comprises a Large part of Total Value and is sensitive to small
changes

Capitalizes FCF after definite forecast period as a growing perpetuity;

Estimate Terminal Value using Terminal Value Multiplier applied on last
year cash flows
Gordon Formula is often used to derive the Terminal Cash (1 + g)
Flows by applying the last year cash flows as a multiple of
(WACC g)
the growth rate and discounting factor
Estimated Terminal Value is then discounted to present day at companys
cost of capital based on the discounting factor of last year projected cash
flows

IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation

Multiples to the Terminal Year Financials and also doing Scenario Analysis.

Pricing Guidelines for Buyback of Equity shares, CCPs or

CCDs issued to Non resident under FDI policy

Earlier Practice

Now

After 9th Jan, 2014

Particulars

Before 9th Jan, 2014

RBI bi-monthly Monetary

Policy

Equity Shares

Statement - 1 April 2014

CCP's and CCD's

The Price should not be

Listed
Company

more than price

It has been decided to

Market Price prevailing at recognized stock

determined on the

withdraw all the existing

Exchange

guidelines relating to

basis of SEBI

valuation in case of any

guidelines
Not more than price arrived Price
The price should not be
Unlisted

Company

more than fair value of

shares as per the
Discounted Free Cash
Flow Method (DFCF)

as

on the basis of Return of Internationally

per
accepted

Equity as per latest Audited pricing methodology at

Balance Sheet.

the

time

of

ROE = PAT / Networth certified

(Note: Networth would

registered

include all reserves and Banker

paid-up capital)

by

Account

exit

duly
SEBI

Merchant
or

Chartered

acquisition/sale of shares
and

accordingly,

such

transactions

will

henceforth be based on
acceptable
market

practices.

Operating guidelines will

be notified separately

An Insight of Valuationwww.CorporateValuations.in

SEBI / Stock Exchange

Valuation Guidelines

Takeover Regulations
APPLICABLE LAW:
SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011
Traded Turnover of Shares 10%

FREQUENTLY TRADED
SHARES

[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

Method of Valuation
1.

Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A.

2.

The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks;

3.

The Highest Price paid or payable by acquirer or PAC in last 26 Weeks;

4.

Volume weighted average Market Price of Shares for a period of 60 trading days

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A.

INFREQUENTLY TRADED
SHARES

Traded Turnover of Shares < 10%

[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]

Method of Valuation
1.
2.

Book value,
Comparable Trading Multiples;

Such other Parameters as are customary for valuation of shares of such companies

Preferential Issue (1 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009

Equity shares of issuer have been listed on recognized stock exchange for a period of 26
weeks or more as on relevant date

Method of Valuation
1.

The average of the weekly high and low of the closing prices of the related equity shares quoted on
the recognised stock exchange during 26 weeks preceding the relevant date, or

2. The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during 26 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Preferential Issue ( 2 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009
Equity shares of issuer have been listed on recognized stock exchange for a period of less
than 26 weeks as on relevant date

Method of Valuation
1.

The price at which equity shares were issued by the issuer in its IPO or value per share
arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act,
1956, pursuant to which the equity shares of the issuer were listed, as the case may be ,
or

2. The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during the period shares have been listed
preceding the relevant date, or
3. The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during 2 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Preferential Issue ( 3 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009
Equity shares have been issued to promoters / their relatives for consideration other than
cash, The VALUATION OF ASSETS in consideration for which the equity shares are

issued shall be done by an independent valuer

Method of Valuation
No Method for Valuation has been prescribed.

Valuer
Chartered Accountant or a Merchant Banker

ESOP Accounting Valuation

APPLICABLE LAW:
SEBI (ESOS and ESPS) Guidelines, 1999
If a Company listed on recognised stock exchange in India and issued shares under an
ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model

(Black-Scholes or a binomial model) which shall be treated as employee compensation cost

for the Company.

Method of Valuation
Black-Scholes Model

Valuer
Not Prescribed

Income Tax Act-1961

Valuation in case of Allotment / Transfer of Shares

Valuation of Shares as per Income Tax Act, 1961
Section

56(2)(vii)
Read with Rule
11U and 11UA(1)

Recipient

Individual,
HUF

Transaction

Situation

Valuation
Method

Quoted Shares
If transaction carried out Transaction
through Recognized
value as
Stock Exchange:
recorded in
such stock
exchange
Lowest price
quoted on any
If transaction carried out
recognized
other than recognized
stock
stock exchange
Receives
exchange on
valuation date;
Shares from
Lowest price
If transaction carried out
any person other than recognised of such shares
on date
stock
exchange
and
no
or persons
immediately
trading has been carried
preceding the
out on valuation date
valuation Date
Unquoted Shares
If shares listed on
NAV (as per
Regional Stock Exchange
Audited
only
Balance sheet
as on
Valuation
Unlisted Shares
Date)

Valuer

SEBI
registered
category-I
Merchant
Banker;
PCA

Valuation in case of Allotment / Transfer of Shares

Valuation of Shares as per Income Tax Act, 1961

Section

Recipient

Transaction

56(2)(viia)

Firm or Receives Shares of

Read with

Closely

Closely held

Rule 11U

held

Company from any

and 11UA(1) Company person or persons

Valuation Method

Valuer

SEBI registered
NAV (as per Audited

category-I Merchant

Balance sheet as on

Banker;

Valuation Date)

PCA

Valuation of Property other than Shares

APPLICABLE LAW:
Section 56(2)(vii) and 56(2)(vii)(a) Income Tax Act 1961 read with Rule 11U and 11UA(1)

If Individual, HUF, Firm or *closely held Company receives property other than shares of a

closely held Company Valuation norms shall apply.

Method of Valuation

Price at which such shares will fetch in the open market.

Valuer
Valuation report to be issued by Merchant Banker

Valuation in case of Issue of Shares

Valuation of Shares as per Income Tax Act, 1961

Section

Issuer

Transaction

Valuation Method

Valuer

NAV
As per Audited Balance
sheet as on Valuation Date

Issues
Closely
Shares to
held
Read with Rule 11U
Person being
Company
and 11UA(2)
a resident
56(2)(viib)

where the balance sheet

on the valuation date has
not been drawn up then
the Balance Sheet
immediately preceding the
valuation Date which has
been approved and
adopted in AGM of the
Company

DFCF

SEBI
registered
category-I
Merchant
Banker;
Fellow
Chartered
Accountant

Any other method as may

be substantiated by the
Company to the
satisfaction of Assessing
Officer

Higher of A and B
This provision do not apply to shares issued to non-residents

Calculation of Networth as per Rule 11UA of Income Tax Act, 1961

Calculation of Networth
All Assets
Less:

All Income Taxes Receivable

Less:

Debit balance of P/L Account

Less:

Unamortized deferred expenditure

Total (A)

All Liabilities
Less:

Paid up Equity share Capital

Less:

Accumulated balance of Profits

Less:

Unamortized deferred expenditure

Less:

Reserves other than depreciation reserves

Less:

Provision for unascertained laibility

Less:

Dividend not declared before date of transfer at general body

of meeting
Provision for Taxation other than amount paid as advance

Less:

tax under the Act, to the extent of excess over the tax

payable with reference to book profits

Less:
Add:

Contingent liabilities
Arrears of dividend payable in repect of cummulative

preference shares
Total (B)

Networth (A) - (B)

Issues Need to be addressed

Issue of
Shares

Situation

Income Tax Act 1961

RBI Guidelines

In case of downstream
Investment
by
Indian
Company (closely held)
having FDI whereby Issue
of shares
has taken
place to resident which
are owned / controlled by
Non resident

As per Section- 56(2)(vii)(b)

FEMA 205/2010-RB

Valuer

A)

NAV /
Price)

B)

Any other method as may

be substantiated by the
Company
to
the
satisfaction of Assessing
Officer
Higher of A or B

SEBI Registered category

I Merchant Banker or
FCA

Transfer
of Shares

In case of downstream
Investment
by
Indian
Company (closely held)
having
FDI
where
Transfer of shares has
taken place to resident
which
are
owned
/
controlled
by
Non
resident
Valuer

DFCF

(Maximum

If
unlisted
Company
/
Company
not
listed
on
recognized stock exchange:
DFCF (Minimum price)

As per Section- 56(2)(vii)(a)

NAV
(As
per
Balance
sheet
Valuation Date)

Audited
as on

SEBI Registered category

I Merchant Banker or
PCA

SEBI Registered category

I Merchant Banker or
CA
Circular No. 49 of RBI

If
unlisted
Company
/
Company
not
listed
on
recognized stock exchange:
DFCF

SEBI Registered category

I Merchant Banker or
PCA

Some Corporate transactions

Situation

Our Interpretation
The Supreme Court in CWT Vs Trustees of HEH Nizams Family

If any trust receives shares of closely held

Company on behalf of Closely held
Company or firm

(Remainder Wealth) Trust 108 ITR 555 held that the trustees are
assessable in the like manner and to the same extent as the
beneficiaries. Therefore taxability under Section 56 is
dependent on type of beneficiary i.e. whether it is Individual /
HUF, Firm / Closely held company.

Whether

Receipt

of

Convertible

Debentures would be covered under

Section

56(2)(vii)(b)

56(2)(vii)(a)

or

Section

The Rajasthan High Court in case of Commissioner of Income-tax

v Secure Meters Ltd 321 ITR 611 held that "debentures when
issued is a loan and therefore whether it is convertible or
non-convertible does not militate against the nature of
debenture, being loan

Some Corporate transactions (Cont.)

As per the section 56 The receipt of shares is no doubt a prerequisite for being taxed. However, such shares should be the
property of the person from whom it is received.
Bonus shares represent capitalization of the profits and the
right to receive profits embedded in the shares fructifies into
the bonus shares. In other words, realization of pre-existing
Whether Receipt of Bonus Shares or
rights
cannot
be
regarded
as
receipts.
Right shares would be taxable under
Section - 56
Likewise Rights shares, so popularly referred, represent
entitlement to the further issue of capital by a company, by
way
of
inherent
right.
Therefore, Neither Bonus shares nor Right shares of the
issuing company be regarded as its property and therefore
issue of the same would not be taxable under Section - 56

Recent in the case Sudhir Menon HUF vs. ACIT (ITAT Mumbai)
it was held that issue of additional shares to the extent it is
Whether Further issue of shares on
proportional to the existing share-holding would be regarded as no
proportionate basis to the exiting
additional property have been received by the shareholder.
shareholding is taxable under Section - 56
therefore issue of the same would not be taxable under
Section - 56

ESOP Tax Valuation

APPLICABLE LAW:
Income Tax Act 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT

To determine the value of perquisite taxable in hands of employees

Method of Valuation

No method has been prescribed

Valuer
SEBI registered category I Merchant Banker

Accounting Valuation

Purchase Price Allocation

What is a Purchase Price Allocation?
-

an acquiring entity must allocate the purchase price to the assets

acquired and liabilities assumed based on estimated fair values at the
date of acquisition;

The excess of the cost of an acquired entity (including tangible and

intangible assets) over the net of the amounts assigned to assets
acquired and liabilities assumed is recorded as Goodwill;

Tangible Assets
In Proportion
to Fair Value

Consideration
paid for
acquisition

Allocated to

Intangible Assets

Goodwill

Balancing
Figure

Purchase Price Allocation

Why Purchase Price Allocation?

Intangible assets recognized separately from goodwill must be valued

and amortized for financial reporting purposes, if appropriate

This may result in better Tax planning for undertaking the

transactions of acquisition of assets and liabilities; Under Slump
sale transaction, specifically the Intangible Assets can be
separately accounted for by the Acquirer and Depreciation also
claimed under the provisions of Indian Income Tax Law.

PPA is used to allocate the Business Value between Tangible

and Intangible Assets.

Part C
Registered Valuer

Registered Valuer Sec 247

Registered Valuer
Stock, Shares,
Debentures,
Securities,
Goodwill

Shall have 5 Years

of Continues
Experience

Property

Financial Valuer

Technical Valuer

Chartered

Accountant,
Secretary

Company
or

Cost

Accountant
having in employment
under it, either a
chartered accountant
or company secretary
or cost accountant and
either of whom shall
have continuous
experience of five
years

Banker

with

Securities
Exchange
India

of

the

Institute of Engineers
or

Member

of

Shall have 5 Years of

Continues Experience

the

Institute of Architects

Merchant

registered

Member

Board

Merchant

the

registered

and

Securities

of

Exchange

India

Banker

with

the
and

Board

of

having in employment
under it, either a
member of Institute of
Engineers / Architects
and either of whom
shall have continuous
experience of five
years

Registered Valuer Sec 247

Further Issue
of Shares
Corporate
Debt
Restructuring

Registered
Valuer

Compromise
and
Arrangements
Registered
Valuer

Values
Exit to
Minority
Shareholders

Valuer not to be interested

Valuer to exercise due diligence
Valuation to be done as per rules
Valuer liable for damages on default

Winding up /
Liquidation
Non Cash
Transactions
with
Directors

Part D
Tricky Issues

Discounts
Discounts & Premiums come into picture when there exist difference between the
subject being valued and the Methodologies applied. As this can translate control value
to non-control and vise versa , so these should be judiciously applied.

Impact on entity as a whole

Discount for Entity Level

Key Person Discount

Global Studies over the years on diversified

Discount for Contingent Liability

companies and holding companies has shown

Discount for diversified company

that companies trade at a discount in the range

Discount for Holding Company

of 20%. to 40% each.

Tax Payout
Discount for Shareholders Level Impact on specific ownership interest
Discount Lack of Control (DLOC)

Discount Lack of Marketability (DLOM)

DLOM:

As

per

CCI

Guidelines,

15%

% stake & special rights

discount has been prescribed; however

Size of distribution or dividends

practically DLOM and DLOC depends upon

Dispute

following factors:

Revenue / Earning Growth / Stability

Private Company
Shareholders Agreement caveats

Premium
Control Premium -

An investor seeking to acquire control of a company is typically

willing to pay more than the current market price of the
company. Control premium is an amount that a buyer is usually
willing to pay over the fair market value of a publicly traded

company to acquire controlling stake in a company

Research has shown that the control premium in
India has ranged from 20% to 37% in the past few
years.

Excess Cash and Non Operating Assets

Excess cash is defined as total cash (in balance
sheet) operating cash (i.e. minimum required cash)
to sustain operations (working capital) and manage
contingencies
Key Issue: Estimation of Excess Cash ?

One of the solutions is to estimate average

cash/sales or total balance sheet size of the
companys relevant Industry and then estimate if
the company being valued has cash in excess of the
industrys average.
Non operating Assets are the Surplus assets which are not used in operations of the business and does not
reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should be
separately added to the value derived through valuation methodologies to arrive at the value of the company.
What is an asset is not yielding adequate returns ?

Cross Holding and Investments

Holdings in other firms can be categorized into:

Types of Cross Holding
Minority, Passive Investments

Meaning
If the securities or assets owned in another firm represent less
than 20% of the overall ownership of that firm

Minority, Active Investments

If the securities or assets owned in another firm represent

between 20% and 50% of the overall ownership of that firm

Majority, Active Investments

If the securities or assets owned in another firm represent more

than 50% of the overall ownership of that firm

Ways to value Cross Holding and Investments:

Investment Value

By way of

Dividend Yield Capitalization or DCF based on expected dividends

Agreement
holding

Seperate Valuation (Preferred)

Shareholders
even

may

control value

less

command

Accounting Practices and Tax issues

Most of the information that is used in
valuation comes from financial statements.
which

in

turn

Accounting

are

practices

appropriate.
Cash Accounting v/s Accrual Accounting
Operating Lease v/s Financial Lease
Capitalization of Expenses
Notional Tax vs. Actual Tax
Treatment of Intangible Assets
Companies Paying MAT

Treatment of Tax benefits and Losses

made

on

certain

considered

Valuation Methodologies and Value Impact

Major Valuation Methodologies

Ideal for

Result

Net Asset Value

Net Asset Value (Book Value)

Minority Value
Equity Value

Net Asset Value (Fair Value)

Control Value

Comparable Companies Multiples (CCM) Method

Price to Earning , Book Value Multiple
EBIT , EBITDA Multiple

Minority Value

Equity Value
Enterprise Value

Comparable Transaction Multiples (CTM) Method

Price to Earning , Book Value Multiple

Equity Value
Control Value

EBIT , EBITDA Multiple

Enterprise Value
Discounted Cash Flow (DCF)

Equity
Firm

Control Value

Equity Value
Enterprise Value

IRS Revenue Ruling (1959-60),USA

Revenue Ruling (RR) 1959-60 is one of the oldest guidance available on Valuation in the
world but still most relevant for Tax Valuations specifically for Valuing closely held
common stock. It is the most widely referenced revenue ruling, also often referenced for
Non Tax Valuations.

While Valuing , it gives primary guidance on eight basic factors to consider Nature of the Business and the History of the Enterprise from its inception
Economic outlook in general and outlook of the specific industry in particular
Book Value of the stock and the Financial condition of the business
Earning Capacity of the company
Dividend-Paying Capacity of the company.
Goodwill or other Intangible value
Sales of the stock and the Size of the block of stock to be valued
Market prices of stock of corporations engaged in the same or a similar line of business

Thank You
Mr. Chander Sawhney
Vice President
Mob. +91 9810557353
E-Mail: chander@indiacp.com

62

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