Where ‘an­gels’ are be­dev­illed

Tar­get­ing share val­u­a­tion causes pain for start-ups. Re­strain­ing shell firms needs a dif­fer­ent ap­proach

The Hindu - - BUSINESS REVIEW - P W C Davi­dar

For the past few months, ‘an­gel tax’ is­sues have taken cen­tre stage. Cir­cu­lars have been is­sued with the hope that the mat­ter would be re­solved to ev­ery­one’s sat­is­fac­tion. The Depart­ment of Pro­mo­tion of In­dus­try and In­ter­nal Trade (DPIIT) is at­tempt­ing to move a fresh set of so­lu­tions to pour wa­ter on this rag­ing is­sue.

From the face of it, a pub­lic pol­icy meant to curb shell com­pa­nies has turned into an at­tack on gen­uine in­vest­ments; and, the so­lu­tion it­self has be­come a prob­lem. Does the Depart­ment need to take a fresh look at Sec­tion 56 (2) in light of the vis­i­ble out­comes of a pub­lic pol­icy gone wrong? We will wait and watch. Till then, let us re­visit the is­sue it­self.

The fo­cus was on pro­mot­ing pri­vate sec­tor in­vest­ment in the coun­try. This be­ing the base, all other pro­cesses and rules should run con­sis­tent with this foun­da­tion. But, it is this premise which is tak­ing a beat­ing and hence the need to ad­dress it.

Ev­ery in­vestor has a view as to whether a ven­ture is worth in­vest­ing in, by cal­cu­lat­ing likely re­turns. The en­tre­pre­neur seek­ing in­vest­ment has also de­ter­mined the ex­tent of con­trol and own­er­ship to be sur­ren­dered in re­turn for funds.

Both bal­ance their in­ter­ests to se­cure the max­i­mum pos­si­ble re­turns. To pro­tect their re­spec­tive long-term in­ter­ests, both would be un­will­ing to com­pro­mise on their view. In case of doubt, the in­vestor has re­course to the busi­ness plan to con­vince him­self that his as­sump­tions are ac­cu­rate.

Now, into what should be en­tirely the do­main of the ‘pri­vate’ sec­tor, we have brought ‘gov­ern­men­tal con­trol’, to the ex­tent that what­ever deal may be struck be­tween the in­vestor and the en­tre­pre­neur, they are plagued with hav­ing to sat­isfy a clause which can be a threat to the en­tire ven­ture on ac­count of an un­fac­tored tax bur­den.

Sec­tion 56 (2) (vii)(b) of the In­come Tax Act pro­vides for ‘where a closely held com­pany is­sues its shares at a price more than its fair mar­ket value, the amount re­ceived in ex­cess of the fair value will be taxed as in­come from other sources’. The de­ter­mi­na­tion of fair mar­ket value be­comes the bone of con­tention. It now comes un­der the do­main of the ‘Assessor’ — mean­ing the In­come tax depart­ment. The depart­ment takes a look at the busi­ness plan and be­gins to check whether the turnover and busi­ness re­turns en­vis­aged were achieved.

Val­u­a­tion stale­mate

If they weren’t, the depart­ment faults the busi­ness plan and con­cludes that the val­u­a­tion was much higher than what it should have been. Most busi­nesses in our coun­try are sub­ject to flux on ac­count of laws that are con­stantly be­ing moved around. Then there is the mar­ket sit­u­a­tion which is not guar­an­teed, ei­ther. Even if the in­vestor is will­ing to wait for re­turns, the tax depart­ment is not. Due to volatile mar­kets, cou­pled with tax is­sues, most fi­nan­cial ad­vis­ers do not rec­om­mend for­ma­tion of pri­vate lim­ited com­pa­nies. Strangely, it is com­mon to find in re­cent times busi­nesses — that could have eas­ily ben­e­fited from the pri­vate lim­ited tag and then be­com­ing pub­lic lim­ited com­pa­nies — still re­main­ing as part­ner­ships or worse, sole pro­pri­etor­ships.

Our ecosys­tem is not con­ducive for real growth in the pri­vate sec­tor un­less you have learnt to ‘han­dle the sys­tem’.

If the govern­ment is con­cerned about ‘shell com­pa­nies’, it would need to at­tack the is­sue head-on and de­fine a shell com­pany. What would qual­ify a com­pany to be one? Once the iden­tity of a shell com­pany has been de­ter­mined, the penalty for the same can then be de­cided.

This would be bet­ter than tar­get­ing share val­u­a­tion in a com­pany, which is cru­cial to at­tract­ing in­vest­ment. Cur­rently, there is no dis­tinc­tion be­tween a com­pany func­tion­ing with gen­uine trans­ac­tions and one that isn’t.

Some food for thought: isn’t it suf­fi­cient that the share premium and the stake of­fered sat­isfy pro­mot­ers and in­vestors? Is there a need to lay bound­aries to this as­pect of free mar­ket en­ter­prise? Is fair mar­ket value con­stant and con­sis­tent, year-on-year; and are ex­tra­ne­ous in­flu­ences the same all around?

Laws in­ad­e­quate?

If money in ex­cess ‘ap­pears’ to be pumped into a pri­vate lim­ited com­pany and the source of such funds doubt­ful, aren’t ex­ist­ing laws (Sec­tion 68 or 69 of the In­come Tax Act, 1961) suf­fi­cient for the au­thor­i­ties to de­ter­mine and tax ac­cord­ingly with­out hav­ing to en­ter into the share val­u­a­tion sphere?

Is Sec­tion 56 (2)(vii)(b) of the In­come Tax Act, 1961 de­ter­ring the flow of in­vest­ments into pri­vate lim­ited com­pa­nies? If it is non-ne­go­tiable and will con­tinue to re­main so even for the most straight-for­ward trans­ac­tions, how can gen­uine pri­vate lim­ited com­pa­nies that seek cap­i­tal in­fu­sion for ex­pan­sion/con­sol­i­da­tion be pro­tected from in­ter­pre­ta­tions that could lead to lay­ers of lit­i­ga­tion with huge tax levy to be fought at dif­fer­ent lev­els up to the apex court?

Cur­rently, con­sul­tants of­ten discourage en­trepreneurs from form­ing pri­vate lim­ited com­pa­nies due to fac­tors that in­flu­ence ease of in­vest­ment and func­tion­ing.

Pub­lic poli­cies in this area di­rectly im­pact the ecosys­tem af­fect­ing the growth of pri­vate lim­ited com­pa­nies. Per­haps, ‘an­gel’ tax has got to go if pri­vate lim­ited firms are to flour­ish in In­dia.

(The writer is Re­tired Ad­di­tional Chief Sec­re­tary, Govt. of Tamil Nadu)

GETTY IM­AGES/ISTOCK ■

In a nut­shell: The Cen­tre must first de­fine a ‘shell’ firm. It can then pe­nalise such com­pa­nies.

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