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This article is written by Sudarshan Roy, from Heritage Law College, Calcutta University. This article deals with valuations under regulatory compliances in India and people who are authorized to perform valuation under different regulatory statutes. 

Bird’s eye view

On the 18th of October, 2017, a new section of the Companies Act, 2013, i.e. Section 247 and the Companies (Registered Valuers and Valuation) Rules, 2017 came into effect. With these developments, the concept of “Registered Valuer” (RV) came into the picture. This was a step towards standardizing the valuation process in line with global practices. 

In India, the practice of valuation of assets and liabilities of a company does not seem to be based on any structured and uniform plan. There are not many formal mechanisms to govern the practice of valuation in India. In this scenario, the steps mentioned above are a genuine attempt to regulate the process and practice of valuation in this country. 

Valuation is covered by the Companies Act, 2013 but in many cases, there are other regulatory compliance mentioned in different statutes required to be fulfilled. That’s primarily because a transaction may attract the applicability of more than one regulatory compliance. In cases where the transaction is impacted by regulatory authorities like FEMA, Income Tax Department (under the Income Tax Act, 1961), SEBI (under the Securities and Exchange Board of India Act, 1992), etc. these authorities might seek to govern the process of valuation. 

Registered valuer under the Companies Act

No previous company law other than the Companies Act, 2013, had any provision for valuation or mention of who can perform the functions of a valuer. As stated above, Sec 247 came into play for matters requiring valuation under the said Act. 

Section 247 provides that, when there is a requirement of valuation of any property, stocks, debentures, shares, securities or goodwill, or any other asset, or net worth of a company, or its liabilities under the provisions of this Act it shall be performed by a “Registered Valuer”.

Eventually, the question of eligibility of a “Registered Valuer” arises. This issue has been addressed by the Companies (Registered Valuers and Valuation) Rules, 2017 (the Rules). It also talks about the manner of obtaining the certificate for being a registered valuer. 

Apart from these two aspects, the rules also provide for the Insolvency and Bankruptcy Board of India (IBBI), established under the Insolvency and Bankruptcy Code, 2016, to be the “registering authority” which will conduct examinations for the qualification of “registered valuer” and grant certifications in this regard.

The practice of valuation under the Companies Act

Section 247(2) provides for how the valuation is to be performed under the Companies Act. It states that a registered valuer needs to make a fair, impartial, and true valuation of assets of a company that is required to be valued. It also provides for due diligence to be performed by the valuer during the valuation. Furthermore, it states that the valuer has to perform the valuation according to the rules as may be prescribed by the Ministry of Corporate Affairs

Apart from the above-mentioned duties, there are restrictions imposed upon a registered valuer under Section 247(2). A registered valuer is prohibited from undertaking the valuation of any asset in which he has any direct or indirect interest, or becomes so interested at any time during or after the valuation.

Rule 16 of the Companies (Registered Valuers and Valuation) Rules, 2017 also sets out valuation standards to be undertaken by a registered valuer. This Rule states that valuations shall be performed as per the valuation standards notified from time to time by the central government, thus giving powers to the central government to notify methods to be adopted for valuation. Furthermore, it provides that, until there is any prescribed notification from the central government the registered valuer shall perform the valuation according to:

  1. An internationally accepted valuation methodology; 
  2. Valuation standards adopted by any valuation professional organization, or 
  3. Valuation standards are specified by the Reserve Bank of India, Securities, and Exchange Board of India, or any other regulatory body.

Valuation requirements in other statutes

In many cases, transactions are not only covered under the Companies Act, 2013 but provisions of other statutory regulations also get attracted, like; the FEMA, SEBI regulations, Income Tax Act, 1961, etc. For instance, the fresh issue of shares by a Private Limited Company to an overseas shareholder attracts valuation under the Companies Act but also provisions of valuation from FEMA, Income Tax Act, etc.

Valuations under the Reserve Bank of India Act, 1934

Valuations under the Reserve Bank of India Act, 1934, triggers in two scenarios:

  1. Issue or transfer of equity shares or compulsory convertible instruments of an Indian company is taking place between a resident company and a non-resident company, Foreign Direct Investment valuations get attracted. 
  2. When an Indian company acquires or transfers, equity shares in an overseas company Overseas Direct Investment valuations get triggered.

For share transactions, ODI and FDI valuations are required to be performed.

Methodologies

In the case of FDI valuation, the fair valuation of shares on an arm’s-length basis has to be done by any internationally accepted methodology. In the case of ODI valuations, no such methodology has been prescribed. 

Who can perform these valuations

According to the Reserve Bank of India guidelines, Only a SEBI (Securities and Exchange of India) registered Merchant Banker (Cat-1) can do the valuation if the transaction exceeds USD 5 Million or the transaction pertains to the swap of shares.  

RBI has not mentioned which internationally recognized methodology shall be used so a valuer has to choose a suitable methodology in case of FDI valuations on its own depending on a case-to-case basis.

Valuations under the Income Tax Act

Valuations for various provisions of the Income Tax Act have been covered under Rules 11U, 11UA, 11UAA, and 11UAB. 

Methodologies

  1. NAV method: There is no mention of a specific person to do the valuation and therefore any registered valuer can perform the function of valuation based on a fair market value.
  2. DCF method: Rule 11UA(2)(b) deals with Discounted Cash Flow Method of valuation. This is basically the fair market value of a business, based on the value of projected cash flows that a business is expected to generate in the future. 

Valuations under the FEMA Act

FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 is the Act that regulates the transfer of capital instruments. This Act allows a person residing outside India to transfer his capital assets in an Indian company to a resident Indian by way of sale and vice-versa. The whole transfer is governed according to the regulations of this Act. This sale is basically done at the value prescribed by the transfer guidelines under FEMA. As per these guidelines, the transfer should be done at arm’s length price according to any internationally accepted methodology. 

In practice, the expression “internationally accepted pricing methodology” primarily turns to the use of the Discounted Cash Flow method (DCF). In many cases, if there is a need to apply any other internationally accepted pricing methodology other than Discounted Cash Flow Method (DCF) then the background needs to be documented.   

Who can conduct the valuation 

Either the valuation is based on the DCF method or any other method, the valuation has to be performed by a Chartered Accountant or a SEBI registered Merchant Banker. 

Conclusion

Nowadays companies are required to go undervaluation in different stages of their business, and in different circumstances. This paradigm shift in valuations indicates that companies are now required to comply with valuation requirements even on an ongoing basis. On the other hand, valuation is very subjective. Companies are involved in different kinds of businesses. They hold different asset profiles and risk profiles. Thus a valuation practitioner is required to properly navigate all the provisions of an Act or Rule, and all the relevant laws that are attracted to a particular scenario of valuation. The monotonous perspective of a valuation practitioner is harmful to the business interest of a company. Thus a valuation practitioner needs to be updated all the time and must possess a holistic approach towards valuation.  

References


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