The income tax department has started scrutinising valuation of all M&A deals where transfer of shares, second round of funding, or fresh fund infusion, has taken place in the last two years, two people with direct knowledge of the matter said.

The move could lead to a slew of litigations and has impacted several ongoing deals as buyers want to protect themselves against future tax demands, industry insiders said. The I-T scrutiny is being carried out to identify deals where transactions have happened at a price which is either substantially less than or much higher than the fair market value, said people in the know.

While currently no tax notices have been issued, industry trackers say that this could happen in next couple of years.

“The tax authorities are currently undertaking intense scrutiny of M&A deals from valuation perspective, especially the quantum of securities premium infused in the company,” said Punit Shah, partner at tax consultancy Dhruva Advisors.

“Further, newly introduced provisions such as Section 56 and 50 CA specifies deemed fair value of the shares based on some formulas, which may not be consistent with commercially negotiated price by the parties; this results in a double whammy as both the parties to the transactions are taxed on the notional values,” he said.

Section 56 of the Income Tax Act empowers revenue authorities to levy tax on deals where valuation of a company’s shares exceeds the fair market valuation. Section 50 CA, applicable from April 1, deals with situations where transactions have happened at below the fair market value.

Tax officials are also scrutinising transactions under Section 68 of the Income Tax Act that deals with unexplained credits.

People close to the development said questions are also being raised in cases where group companies made equity investments. In several cases, the taxman has already started scrutinising such deals, they said.

Experts feel taxation in valuations would become one of the biggest points of litigation in next two years.

“After transfer pricing and indirect transfers, valuations will see the next wave of litigation,” said Jeenendra Bhandari, partner at tax firm MGB and Co LLP. “Many companies could see litigation around valuations in the next couple of years as the tax authorities have started questioning transfer of shares, capital infusion and M&A,” he said.

Tax experts in the know avow that valuations in almost every transaction could be challenged under one section or another in the coming months.

In one instance, the tax adjustment could be around Rs 200 crore, a person close to that deal said. “The company had bought about 2 lakh shares at Rs 37 per share in one of its fully owned subsidiary. Questions are now being raised (by tax officials) as to why the deal did not happen at Rs 40 per share, as this was the price which was

In another deal, tax authorities questioned a transaction where a share premium was paid by a private equity fund for buying a substantial stake in a subsidiary of an Indian company for close to Rs 2,000 crore. Tax authorities are scrutinising if the PE firm paid a premium and if this could lead to taxation after triggering unexplained credit provisions, said a person in the know.

“Tax officers are questioning why the deal happened at valuations lower or higher than the price mentioned in the valuation report, even in situations where capital infusion happened in a fully owned subsidiary of a company,” Bhandari of MGB said.

A tax of around 30% could be levied on the difference where a deal happens at a valuation perceived to be either more than or less than the fair market value, experts said. What possibly triggered this development was a letter by Central Board of Direct Taxes (CBDT) on January 10, which asked senior income tax officials to look out for “unexplained credits” in the books of companies.

The letter prescribed procedures for tax officers to scrutinise “unexplained credits” in the books of companies under Section 68 of the Income Tax Act.

In the last two years, tax sleuths have questioned many startups under the said section for receiving funds from angel investors at valuations higher than fair market value. Now, insiders said, this section could be triggered against some bigger companies and bigger deals.