The income tax department has allowed use of the discounted cash flow method for determining fair market value of unquoted equity shares.

For this purpose, the income tax rules have now been amended by the Central Board of Direct Taxes (CBDT).

Discounted cash flow method is now a recognised option available for ascertaining the fair market value. Till date, the fair market value of unquoted equity shares was decided only on net asset value basis. This latest CBDT move is seen as a booster dose for domestic private equity industry, which have mostly unregistered players.

Finance Minister P Chidambaram has now removed the bottleneck faced by the private equity industry by allowing the use of discounted cash flow method.

A discounted cash flow is a value of future expected cash receipts and expenditures at a common date, which is calculated using net present value or internal rate of return.

This is a factor in analyses of both capital investments and securities investments.

Domestic private equity players were affected by the budget provision that sought to clamp down on closely-held companies issuing shares at premium over the fair market value.

ANTI-ABUSE PROVISION

The Budget 2012-13 move was an anti-abuse measure and intended to prevent circulation of unaccounted money.

It required closely-held companies to pay income tax on the premium they charged over the fair market value while selling shares to unregistered investors, including private equity funds.

But it had an unintended consequence of making it tougher for domestic private equity funds to invest in so-called sunrise industries.

This was because the excess premium over fair market value attracted tax at the hands of the investee companies. This reduced the quantum of funds that was available for deployment.

Amit Maheshwari, Partner, Ashok Maheshwary & Associates, a firm of chartered accountants, said that the introduction of discounted cash flow method would facilitate investments by resident unregistered venture capital funds.

Such funds generally invest at a premium, taking into account the estimated cash flow of the investee companies, he said.