Can Valuation under Income Tax Act, 1961 be used under Ind AS 109?

We know that investments in equity instruments are financial assets under Ind AS 109. Such financial assets are to be classified either at Fair Value through Other Comprehensive Income (FVTOCI) or at Fair Value through Profit and Loss (FVTPL). Accordingly, these financial assets are to be measured at their fair value both at initial recognition and at subsequent recognition.

Investments in equity instruments are not allowed to be classified at 'Amortised Cost' due to their specific nature and practical difficulty in application of business model and contractual cash flow test.        

However, there are exception to this measurement principle. Investments in subsidiaries, associates and joint ventures can be measured at cost in terms of Ind AS 27 and Ind AS 28. This practical expedient is a choice given by the standard(s) and I am yet to see an entity not choosing this option . For subject matter purposes, those investments are outside this discussion.

As emphasised above, investments in equity instruments are to be classified either at FVTPL or FVTOCI. FVTOCI classification is based on irrevocable election by the entity at initial recognition. Such election can also be made instrument-to-instrument basis. Equity instruments held for trading are always classified at FVTPL only. This makes FVTPL classification as a residual category wherein all equity instruments are categorised except for irrevocable election at FVTOCI and instruments held for trading.

In addition to this, both categorisation adopt different measurement and recognition principles.

Many Ind ASs permit or require entities to measure or disclose the fair value of assets, liabilities and equity instruments. Readers' attention is invited to the fact that Ind AS 113 does not address which assets or liabilities to measure at fair value and when those measurements must be performed: an entity must look into relevant standard(s) in this regard. Ind AS 113 includes extensive disclosure requirements as well.

1. What exactly is fair value?

"Fair value is the price to sell an asset or transfer liability and, therefore represent an exit price and not an entry price."

Ind AS 113 prescribes "highest and best use" principle only for non-financial assets. Therefore, fair valuation measurement is applied differently to non-financial assets and other assets.

2. Fair value hierarchy in Ind AS 113

To increase consistency and comparability in fair value measurements, Ind AS 113 has established hierarchy that categorises into three levels: the inputs to valuation techniques used to measure fair value.

Level-1 inputs: Quoted price ("unadjusted") in active markets for identical assets or liabilities that the entity can access at the measurement date. A quoted price in an active market is the most reliable estimate of the fair value and shall be used without adjustment.

Level-2 inputs: Inputs other than quoted prices (included in Level-1) that are "observable" for the asset or liability either directly or indirectly. E.g. quoted price of similar assets or liabilities in an active market, quoted price of identical assets or liabilities in a non-active market. Level-2 inputs require adjustments depending on specific factors affecting assets or liabilities like location or condition, volume of activities, etc.

Level-3 inputs: Inputs that are "unobservable" for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that relevant observable inputs are not available.

The objective of fair value measurement remains the same, ie, an exit price at the measurement date.        

3. Valuation under the Income Tax Act, 1961

Valuation under the Income Tax Act, 1961 ("IT Act") are made in accordance with Rule 11UA. Rule 11UA prescribes the valuation methodology for determining Fair Market Value (FMV) of numerous types of assets (including unquoted equity shares). Earlier, there were only two methods prescribed for the purpose of valuation i.e. Net Asset Valued Method (NAVM) and Discounted Free Cash Flow Method (DCF). However, on the backdrop of inclusion of non-residents in 'Angel Tax' w.e.f. 01 April 2024, number of method has increased, including some international method as well.

4. Disclosure requirements under Ind AS 113

Among many disclosure requirements prescribed under Ind AS 113, an entity is required to disclose following (related to valuation):

• Valuation techniques used to measure fair value; and
• Significant unobservable inputs.

The disclosure requirements mentioned supra are only for Level-2 and Level-3 fair values. Since, Level-1 measurement is based on quoted price in an active market, such disclosures are otiose.

5. Taking the stand

First and foremost question that arises is that of suitability of valuation conducted under the IT Act for the purpose of compliance with Ind AS 113. A straight forward answer to this question would be 'No', simply because every valuation exercise must be accommodated with the purpose of valuation through insertion of a separate para in valuation report. If the purpose is to arrive at a sale price of equity instrument (which is mostly the case with IT Act valuation), it would be incorrect to consider such valuation report for the purposes of measurement of fair value under Ind AS 113. In fact, the question which is worth considering is 'whether valuation technique allowed under IT Act can be suitable for Ind AS 113 as well?'

Ind AS 113 sets out a framework for measuring fair value and require disclosures. It mandates an entity to use appropriate valuation technique that maximises the use of relevant observable inputs and minimises the use of unobservable inputs. Valuation techniques like DCF or NAVM prescribed under IT Act can be very much used to determine fair value under Ind AS 113.

Additionally, Ind AS 113 emphasises a lot in fair value being an 'exit price'. So ideally, price determined by using techniques allowed by taxation laws can be considered as an appropriate representation of an exit price.

6. Conclusion

To sum u, an entity can use valuation technique of IT Act to arrive at fair value of unquoted equity instrument in such a way that valuation reflects adherence to the framework of Ind AS 113. Some factors that should be kept in mind are:

• Purpose of valuation must be commensurate with Ind AS 113;
• Valuation techniques should be clearly disclosed in both valuation report and financial statements of the entity; and
• Entity needs to identify significant unobservable inputs used in valuation. Eg, if entity is using DCF method, Weighted Average Cost of Capital (WACC) could be that significant unobservable input.

Caveat Emptor!

This is a personal opinion of the author and is based on principle of Ind AS 113. Every opinion, in our profession, is argumentative in nature. Readers are advised to use their own judgement.