Regulatory Environment

Due Diligence, Legal andRegulatory Valuation aspects

In the business world, the rearview mirror is

always clearer than the windshield

Warren Buffett

Valuation in Indian Regulatory

Environment

Dated: 30th April, 2014

Contents

Particulars Pg. No.

Part A

Overview of Valuation 3

Part - B

Valuation in Indian Regulatory Environment 13

Part - D

Tricky Issues 54

Part - C

Registered Valuer 51

Part A

Overview of

Valuation

Value & Valuation

1

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

Growing Cos.

Turnover/Profits: Increasing still Low

Proven Track Record: Limited

Valuation Methodology: Substantially on Business Model

Cost of Capital: Quite High

High Growth Cos.

Turnover/Profits : Good

Proven Track Record: Available

Valuation Methodology: Business Model with Asset Base

Cost of Capital: Reasonable

Mature Cos.

Turnover/Profits: Saturated

Proven Track Record: Widely Available

Method of Valuation: More from Existing Assets

Cost of Capital: May be High

Declining Cos.

`

Turnover/Profits: Drops

Proven Track Record: Substantial Operating History

Method of Valuation: Entirely from Existing Assets

Cost of Capital: N.A.

Turnover/Profits: Negligible

Proven Track Record: None

Valuation Methodology: Entirely on Business Model

Cost of Capital: Very High

Start Up Cos.

Turn

ove

r /

Pro

fits

Time

Valuation across business cycle follow the law of

economics

Economics of Valuation

En

terp

rise V

alu

e

Net Debt#

Equity#

Fixed

Assets

Net Current

Assets

Intangibles

Stakeholders Assets

Valu

e o

f B

usin

ess

# Based on Market Values

Enterprise / Business Value

Valuation Approaches

Income Based

Method

Asset Based

Method

Capitalization of Earning Method

(Historical)

Discounted Cash Flow Method

(Projected

Time Value)

Market Based

Method

Comparable Companies Market Multiples Method

(Listed Peers)

Comparable Transaction Multiples

Method

(Unlisted Peers)

Market Value Method (For Quoted Securities)

Book Value Method

Liquidation Value Method

Replacement Value Method

Contingent Claim Valuation

(Option Pricing)

Price of Recent Investment Method

Rule of Thumb

(Multiples: Customers, Rooms, Seats, No. of visitors

etc.) - Depends upon Industry

Fundamental Method Relative Method

Other Method

CASH FLOW

Investor assign value based on the cash flow they expect to receive in the

future

- Dividends / distributions

- Sale of liquidation proceeds

Value of a cash flow stream is a function of

- Timing of cash Receipt- 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

Thats why DCF is most

prominent valuation

method

Need for Restructuring

Key drivers of valuation

Mergers

IPO

RBI

Income Tax

ESOP

Companies Act

SEBI

Stock Exchange

Purpose Regulatory Accounting

Purchase Price

Allocation

Dispute

Resolution

Company Law

Board/ Courts

Impairment /

Diminution

Arbitration

Mediation

Acquisitions /

Investment

Voluntary

Assessment

Value

Creation

Equity Research

Credit Rating

Corporate

Planning

Valuation depends upon

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;

Choice of Valuation Approaches

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

Rule of Thumb

Part B

Valuation in Indian Regulatory Environment

Inbound Investment DFCF

Outbound Investment Valuer Discretion

Reserve Bank of

India

CA / MB

>5Mn$ - MB, otherwise CA/MB

Transactions Prescribed Methodologies Mandate to be done by

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

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 methodologyCA / MB

Inbound Investment

Acceptable market

practices. Operating

guidelines will be notified

separately

Outbound Investment

Buy back of Equity

shares/ CCPs/ CCDs of

listed co. issued under

FDI policy

Yet to prescribeBuy back of Equity shares

of unlisted co. issued

under FDI policy

Buy back of CCP / CCD of

unlisted co. issued under

FDI policy

New

Old

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 Individual / HUF Firm / Closely held Company Any Person being resident of India

Issuer Any Person Any Person Closely held Company

Capital Asset

Property (Shares /

Securities etc), Sum of

money

Property except shares of

Widely held CompanyShares

Valuer SEBI registered category I MB, PCA SEBI Registered Category I MB, FCA

Exemptions

Payer is any relative/ on

occasion of marriage/

inheritance/ from any trust

/ local authorities.

Transactions which are not regarded

as transfer under Clause (via) or (vic)

or (vicb) or (vid) or (vii) of Section 47

of Income Tax Act, 1961

Venture Capital Company, Venture Capital

Fund, Venture Capital Undertaking

SNAPSHOT OF REGULATORY VALUATIONS IN INDIAIncome Tax

ESOP Tax Valuer Discretion

Income Tax

MB



Takeover Code/ Delisting -

Infrequently Traded

Only Parameters Prescribed

Return on Net Worth, EPS,

NAV vis-a vis Industry

Average

Takeover Code/ Delisting -

Frequently TradedBased on Market Price

ESOP AccountingOption Pricing Model

SEBI

-

PCA/MB

-

Notification:

94/2009 of

CBDT

Transfer PricingArm Length Price -

Stock Exchanges

Preferential Allotment to promoters / their relatives

for consideration other than cash

Valuer Discretion

Companies Act, 1956

Sweat Equity Valuer Discretion

CA / MB

-



Preferential Allotment to Others

Based on 26 weeks / 2 weeks

Market Price -

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

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.

Particulars Valuation before April 21, 2010 Valuation after April 21, 2010

Guidelines in Force CCI Guidelines 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

Methods Prescribed Net Assets Value (NAV)

Profit Earning Capacity

Value(PECV)

Market Value (in case of Listed

Company)

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

in Value Conclusion

As valuation is more Formulae

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.

FEMA Guidelines to Valuation

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

Discounted Free Cash Flow Method (DFCF)

Approaches to FDI Valuation

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 thecash 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.

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

Major Characteristics of DFCF Valuation

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 flows to firm (FCFF) is calculated as

EBITDA

Taxes

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).

FREE CASH FLOWS

Free Cash Flow calculation

DISCOUNT RATE WEIGHTED AVERAGE COST OF CAPITAL

Where:D = Debt part of capital structure

E = Equity part of capital structure

Kd = Cost of Debt (Post tax)

Ke = Cost of Equity

(Kd x D) + (Ke x E)

(D + E)

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

WACC

Cost of Capital calculation

DISCOUNT RATE - COST OF EQUITY

Where:Rf = Risk free rate of return (Generally taken as 10-year Government Bond

Yield)

B = Beta Value (Sensitivity of the stock returns to market returns)

Ke = Cost of Equity

Rm= Market Rate of Return (Generally taken as Long Term average return

of

Stock Market)

SCRP = Small Company Risk Premium

CSRP= Company specific Risk premium

Mod. CAPM Model

ke = Rf + B ( Rm-Rf) + SCRP + CSRP

The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing

Model (Mod. CAPM)

Cost of Equity 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

Flows by applying the last year cash flows as a multiple of

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

(1 + g)

(WACC g)

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

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

Terminal value calculation

Particulars

Earlier Practice Now

Before 9th Jan, 2014

After 9th Jan, 2014 RBI bi-monthly Monetary

Policy

Statement - 1 April 2014Equity Shares CCP's and CCD's

Listed

Company

The Price should not be

more than price

determined on the

basis of SEBI

guidelines

Market Price prevailing at recognized stock

Exchange

It has been decided to

withdraw all the existing

guidelines relating to

valuation in case of any

acquisition/sale of shares

and accordingly, such

transactions will

henceforth be based on

acceptable

market practices.

Operating guidelines will

be notified separately

Unlisted

Company

The price should not be

more than fair value of

shares as per the

Discounted Free Cash

Flow Method (DFCF)

Not more than price arrived

on the basis of Return of

Equity as per latest Audited

Balance Sheet.

ROE = PAT / Networth

(Note: Networth would

include all reserves and

paid-up capital)

Price as per

Internationally accepted

pricing methodology at

the time of exit duly

certified by SEBI

registered Merchant

Banker or Chartered

Account

Pricing Guidelines for Buyback of Equity shares, CCPs or

CCDs issued to Non resident under FDI policy

An Insight of Valuation-www.CorporateValuations.in

SEBI / Stock Exchange

Valuation Guidelines

Traded Turnover of Shares 10%

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

Takeover Regulations

APPLICABLE LAW:

SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011

FREQUENTLY TRADED

SHARES

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.

Traded Turnover of Shares < 10%

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

INFREQUENTLY TRADED

SHARES

Method of Valuation1. Book value,

2. 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

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

Equity shares of issuer have been listed on recognized stock exchange for a period of 26

weeks or more as on relevant date

Preferential Issue ( 2 of 3)

APPLICABLE LAW:


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


quoted on the recognised stock exchange during the period shares have been listed

preceding the relevant date, or


quoted on the recognised stock exchange during 2 weeks preceding the relevant date.

HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE

Equity shares of issuer have been listed on recognized stock exchange for a period of less

than 26 weeks as on relevant date

Preferential Issue ( 3 of 3)

APPLICABLE LAW:


Method of Valuation

No Method for Valuation has been prescribed.

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

Valuer

Chartered Accountant or a Merchant Banker

ESOP Accounting Valuation

APPLICABLE LAW:

SEBI (ESOS and ESPS) Guidelines, 1999

Method of Valuation

Black-Scholes Model

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.

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 Recipient Transaction SituationValuation

MethodValuer

56(2)(vii)

Read with Rule

11U and 11UA(1)

Individual,

HUF

Receives

Shares from

any person

or persons

Quoted Shares

SEBI

registered

category-I

Merchant

Banker;

PCA

If transaction carried out

through Recognized

Stock Exchange:

Transaction

value as

recorded in

such stock

exchange


other than recognized

stock exchange

Lowest price

quoted on any

recognized

stock

exchange on

valuation date;


other than recognised

stock exchange and no

trading has been carried

out on valuation date

Lowest price

of such shares

on date

immediately

preceding the

valuation Date

Unquoted Shares

If shares listed on

Regional Stock Exchange

only

NAV (as per

Audited

Balance sheet

as on

Valuation

Date)

Unlisted Shares


Section Recipient Transaction Valuation Method Valuer

56(2)(viia)

Read with

Rule 11U

and 11UA(1)

Firm or

Closely

held

Company

Receives Shares of

Closely held

Company from any

person or persons

NAV (as per Audited

Balance sheet as on

Valuation Date)

SEBI registered

category-I Merchant

Banker;

PCA

Valuation in case of Allotment / Transfer of Shares

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)

Method of Valuation

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

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

closely held Company Valuation norms shall apply.

Valuer

Valuation report to be issued by Merchant Banker


Section Issuer Transaction Valuation Method Valuer

56(2)(viib)

Read with Rule 11U

and 11UA(2)

Closely

held

Company

Issues

Shares to Person being

a resident

A

NAV

As per Audited Balance

sheet as on Valuation Date

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

SEBI

registered

category-I

Merchant

Banker;

Fellow

Chartered

AccountantDFCF

B

Any other method as may

be substantiated by the

Company to the

satisfaction of Assessing

Officer

Higher of A and B

Valuation in case of Issue of Shares

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

Less:

Provision for Taxation other than amount paid as advance

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

payable with reference to book profits

Less: Contingent liabilities

Add:Arrears of dividend payable in repect of cummulative

preference shares

Total (B)

Networth (A) - (B)

Issues Need to be addressedSituation 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)

A) NAV / DFCF (Maximum

Price)

B) Any other method as may

be substantiated by the

Company to the

satisfaction of Assessing

Officer

Higher of A or B

FEMA 205/2010-RB

If unlisted Company /

Company not listed on

recognized stock exchange:

DFCF (Minimum price)

Valuer SEBI Registered category

I Merchant Banker or

FCA

SEBI Registered category


CA

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

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

NAV (As per Audited

Balance sheet as on

Valuation Date)

Circular No. 49 of RBI

If unlisted Company /

Company not listed on

recognized stock exchange:

DFCF

Valuer SEBI Registered category


PCA

SEBI Registered category


PCA

Issue of

Shares

Transfer

of Shares

Some Corporate transactions

Situation Our Interpretation

If any trust receives shares of closely held

Company on behalf of Closely held

Company or firm

The Supreme Court in CWT Vs Trustees of HEH Nizams Family

(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)(a) or Section -

56(2)(vii)(b)

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.)

Whether Receipt of Bonus Shares or

Right shares would be taxable under

Section - 56

As per the section 56 The receipt of shares is no doubt a pre-

requisite 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

rights cannot be regarded as receipts.

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

Whether Further issue of shares on

proportionate basis to the exiting

shareholding is 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

proportional to the existing share-holding would be regarded as no

additional property have been received by the shareholder.

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

Method of Valuation

No method has been prescribed

To determine the value of perquisite taxable in hands of employees

Valuer

SEBI registered category I Merchant Banker

Accounting Valuation

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;

Consideration

paid for

acquisitionAllocated to

Tangible Assets

Intangible Assets

Goodwill

In Proportion

to Fair Value

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.

Purchase Price Allocation

Part C

Registered Valuer

Registered Valuer Sec 247

Registered Valuer

Financial Valuer Technical Valuer

A Chartered

Accountant, Company

Secretary or Cost

Accountant

A Merchant Banker

registered with the

Securities and

Exchange Board of

India

Member of the

Institute of Engineers

or Member of the

Institute of Architects

A Merchant Banker

registered with the

Securities and

Exchange Board of

India

Shall have 5 Years

of Continues

Experience

Shall have 5 Years of

Continues Experience

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

having in employment

under it, either a

member of Institute of

Engineers / Architects

and either of whom

shall have continuous

experience of five

years

Stock, Shares,

Debentures,

Securities,

Goodwill

Property

Registered Valuer Sec 247

Registered Valuer

Further Issue of Shares

Compromise and

Arrangements

Winding up / Liquidation

Non Cash Transactions

with Directors

Exit to Minority

Shareholders

Corporate Debt

Restructuring

Registered

ValuerValues

Valuer not to be interested

Valuer to exercise due diligence

Valuation to be done as per rules

Valuer liable for damages on default

Part D

Tricky Issues

Discounts

Discount for Entity Level

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

Key Person Discount

Discount for Contingent Liability

Discount for diversified company

Discount for Holding Company

Discount for Shareholders Level Impact on specific ownership interest

Discount Lack of Control (DLOC)

Discount Lack of Marketability (DLOM)

Size of distribution or dividends

Dispute

Revenue / Earning Growth / Stability

Private Company

Tax Payout

% stake & special rights

Shareholders Agreement caveats

Global Studies over the years on diversified

companies and holding companies has shown

that companies trade at a discount in the range

of 20%. to 40% each.

DLOM: As per CCI Guidelines, 15%

discount has been prescribed; however

practically DLOM and DLOC depends upon

following factors:

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 ?

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.

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.

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 Meaning

Minority, Passive Investments 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

Investment Value

Ways to value Cross Holding and Investments:

Dividend Yield Capitalization or DCF based on expected dividends

Seperate Valuation (Preferred)

By way of Shareholders

Agreement even less %

holding may command

control value

Accounting Practices and Tax issues

Most of the information that is used in

valuation comes from financial statements.

which in turn are made on certain

Accounting practices considered

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

Valuation Methodologies and Value Impact

Major Valuation Methodologies Ideal for Result

Net Asset Value

Net Asset Value (Book Value) Minority ValueEquity Value

Net Asset Value (Fair Value) Control Value

Comparable Companies Multiples (CCM) Method

Price to Earning , Book Value MultipleMinority Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Comparable Transaction Multiples (CTM) Method

Price to Earning , Book Value MultipleControl Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Discounted Cash Flow (DCF)

Equity Control Value Equity Value

Firm 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: [email protected]

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