Startups, which is already struggling in India, and unlisted subsidiaries of some major Indian companies and multinationals find themselves caught in the odd situation of being attacked by income tax department for raising funds through preference shares in excess of what it considers the “fair market value”.
It is to be noted that Fair market value (FMV) is an estimate of the market value of a entity, based on what a knowledgeable, willing, and un-pressured buyer would probably pay to a knowledgeable, willing, and un-pressured seller in the market.
The investigation arm of the income tax department has sent notices to about 200 entities (startups, companies) under Section 56(2)(vii)(b) of the Income Tax Act, 1961, in August, two people with direct knowledge of the matter told ET.
Fair market value is assessed by the tax department based on past transactions and the record of similar, comparable companies. The Section is often applied when it’s suspected that companies may be issuing shares at a premium over the fair value for laundering unaccounted cash.
The notices have struck fear in recipients as the government is boasting to go after black money and the gravity with which the investigation arm’s notices are regarded.
These over-the-top exercises by tax department, however, create fear among startups and discourage entrepreneurs to convert their businesses into legal entity or incorporate as companies.
“After questioning startups, the income tax department is now invoking Section 56(2)(vii)(b) to question share premium received by unlisted companies,” said Amit Maheshwari, Partner, Ashok Maheshwary & Associates LLP. “Valuation is very subjective and can be always questioned.
Unlike ‘qualified’ startups, the rest of the universe of unlisted companies doesn’t enjoy immunity from the rigours of the section. If tax officers start questioning valuations of unlisted companies similar to what they did last year in the case of startups, it can lead to a significant increase in litigation.”
Notably, NRIs and foreign nationals are exempted from the law on scrutinizing premiums paid on share issues.
In the case of startups, notices have been sent to those that have seen valuations being marked down in subsequent funding rounds.
Some startups have moved the income tax tribunal against the notices while others have approached their advisers and sought legal recourse.
Ironically, BJP which is the ruling party in India’s central government and nine other states in the country is itself inked of black money as according to a recent report, BJP’s 81% income is from unknown sources and has not been declared in public. Unfortunately, there’s no one keep a check on the political parties especially the one which rules the central government. This is what helps the idea of illicit money to take birth and flourish, and only small startups along with common men are literally harassed in the name of anti-black money exercises.
Besides common man and struggling startups, only entity that can make money be it black or white is “Political Parties” while common men and small startups find in a position to be attacked.
According to report released by the Association of Democratic Reforms (ADR) on Wednesday, in 2015-16, the BJP raised 80.7 percent of its total income from unknown sources. The Congress party got 71.1 percent of its total income from such sources during the comparable period. To put it in actual numbers, the BJP’s total declared income was Rs 570.86 crore and Congress’s Rs 261.56 crore. Out of its total income, the BJP collected Rs 460.78 crore from unknown sources and the Congress Rs 186.04 crore, according to the ADR data.
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