Alternative Investment Funds (AIFs) invest significantly in unquoted equity shares of portfolio companies. The Direct Tax Code (DTC) 2025 prescribes specific valuation rules for unquoted equity shares under Rule 57, which have significant implications for AIF portfolio company fair value reporting. This guide analyses the unquoted equity valuation rules and their application to AIF reporting obligations.
The Valuation Framework Under Rule 57
Rule 57 — Determination of Fair Market Value
Rule 57 of the Income-tax Rules, 2026 prescribes the manner of determining the fair market value of various types of property for the purposes of:
- Section 26(2)(j) — Fair market value of inventory converted into capital asset
- Section 72 — Computation of capital gains
- Section 92 — Income from other sources
Table: Rule 57 — Valuation Methods
| Sl. No. | Nature of Property | Manner of Determination of Fair Market Value |
|---|---|---|
| 1 | Jewellery | (a) Price it would fetch if sold in open market; or (b) Invoice value if purchased from registered dealer; or (c) Report from registered valuer if value exceeds ₹50,000 |
| 2 | Archaeological collections, drawings, paintings, sculptures or any work of art | (a) Price it would fetch if sold in open market; or (b) Invoice value if purchased from registered dealer; or (c) Report from registered valuer if value exceeds ₹50,000 |
| 3 | Quoted shares and securities | (a) Transaction value if traded on recognised stock exchange; or (b) Lowest price quoted on recognised stock exchange |
| 4 | Unquoted equity shares | (A + B + C + D — L) × (PV)/(PE) |
| 5 | Unquoted shares and securities (other than equity shares) | Price it would fetch if sold in open market; report from merchant banker or accountant |
| 6 | Immovable property | Value adopted or assessed for stamp duty |
| 7 | Any other property | Price that property would ordinarily fetch on sale in open market |
Valuation of Unquoted Equity Shares — The Formula
Rule 57 (Table: Sl. No. 4) — Unquoted Equity Shares
The fair market value of unquoted equity shares is determined by the formula:
FMV = (A + B + C + D — L) × (PV)/(PE)
Where:
A = Book value of all the assets in the balance sheet (other than jewellery, artistic work, shares, securities and immovable property) as reduced by:
- Any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any
- Any amount shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset
B = The price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer
C = Fair market value of shares and securities as determined in the manner provided in Rule 57
D = The value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property
L = Book value of liabilities shown in the balance sheet, but not including:
- The paid-up capital in respect of equity shares
- The amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared
- Reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation
- Any amount representing provision for taxation, other than amount of income-tax paid, if any, less the amount of income-tax claimed as refund, if any
- Any amount representing provisions made for meeting liabilities, other than ascertained liabilities
- Any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares
PV = The paid-up value of such equity shares
PE = Total amount of paid-up equity share capital as shown in the balance sheet
Key Definitions
Balance Sheet (Rule 56(a)):
- In relation to an Indian company, the balance sheet of such company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor of the company
- In relation to a company not being an Indian company, the balance sheet of the company as drawn up on the valuation date which has been audited by the auditor of the company, if any
Valuation Date (Rule 56(i)):
- For Section 92: Date on which property or consideration is received
- For Section 79: Date on which the capital asset is transferred
- For Section 26(2)(j): Date on which inventory is converted or treated as a capital asset
Application to AIF Portfolio Company Valuation
1. Determining Fair Market Value
AIFs must determine the fair market value of their portfolio company investments using the formula in Rule 57. This is essential for:
- Fair value reporting to investors
- Tax reporting
- Compliance with regulatory requirements
2. Key Considerations
- Book Value of Assets: As appearing in the audited balance sheet of the portfolio company
- Depreciable Assets: For depreciable assets, the book value after depreciation
- Intangible Assets: Goodwill not acquired by purchase is valued at nil
- Provisions: Provisions for taxation, liabilities, and contingencies must be carefully considered
3. Practical Challenges
- Startups with Limited History: May have limited financial history
- High-Growth Companies: May have significant growth potential not reflected in book value
- Loss-Making Companies: May have negative book value
4. Valuation Date
The valuation date is critical. For AIFs, the relevant valuation date may be:
- Date of receipt of consideration (for Section 92)
- Date of transfer (for Section 79)
- Date of conversion of inventory (for Section 26(2)(j))
Fair Value Reporting Requirements
For AIFs
AIFs must report the fair market value of portfolio company investments:
- In the fund's financial statements
- In investor reports
- In regulatory filings (if required)
For Category I and II AIFs
Category I and II AIFs operate on a pass-through basis for taxation. The fair market value of portfolio company investments may be relevant for:
- Computing capital gains on exit
- Determining the cost of acquisition
- Investor tax reporting
For Category III AIFs
Category III AIFs are taxed at the fund level. The fair market value of portfolio company investments is relevant for:
- Computing capital gains on exit
- Determining the cost of acquisition
- Fund-level tax reporting
Interaction with Other Provisions
Section 92(2)(m) — Income from Property Without Consideration
If an AIF or its portfolio company receives shares without consideration or for inadequate consideration, the fair market value may be treated as income under Section 92(2)(m)(iii). The valuation under Rule 57 is used to determine the fair market value.
Section 78 — Full Value of Consideration
If the consideration received from the transfer of a capital asset is less than the stamp duty value, the stamp duty value shall be deemed to be the full value of consideration.
Section 79 — Full Value of Consideration for Unquoted Shares
If the consideration received from the transfer of a capital asset, being a share of a company other than a quoted share, is less than the fair market value determined under Rule 57, the value so determined shall be deemed to be the full value of consideration.
Compliance Requirements
1. Maintain Proper Records
- Maintain records of portfolio company financial statements
- Maintain records of valuation computations
- Maintain records of assumptions used
2. Obtain Valuation Reports
- For investments exceeding ₹50,000, obtain valuation reports from registered valuers for jewellery, artistic work, and other assets
- For unquoted shares and securities, obtain reports from merchant bankers or accountants
3. Report Fair Value
- Report fair value in the fund's financial statements
- Report fair value in investor reports
- Report fair value in regulatory filings
4. File Tax Returns
- Include fair value information in tax returns
- Ensure consistency between financial reporting and tax reporting
Consequences of Non-Compliance
Incorrect Valuation
If the valuation is incorrect:
- The tax liability may be recomputed
- Interest and penalty may be levied
- The transaction may be challenged
Penalty
Non-compliance may result in:
- Penalty under Section 439 for under-reporting of income
- Penalty under Section 463 for incorrect information in reports
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on unquoted equity valuation for AIF portfolio companies. Our direct tax experts help AIFs understand the valuation rules, compute fair market value, and navigate the regulatory framework. We assist in valuation computation, report preparation, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on unquoted equity valuation or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex unquoted equity valuation framework requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- Valuation Computation: Assistance with Rule 57 valuation
- Report Preparation: Assistance with valuation reports
- Compliance: Guidance on fair value reporting
- Representation: Representation before income-tax authorities
Contact us for expert legal guidance on your valuation matters.