Net Asset Value Method
Net Assets Value (NAV) method is epitome of cost or asset-based approaches of valuation. This
is based on the principle that a business can be viewed as an assemblage of the various assets it
owns. The first thing a valuer does while valuing a business is open the balance sheet and identify
the assets and liabilities.
A company may either carry the assets and liabilities at book value or market value depending on
the accounting standards it follows. Where the company carries its assets and liabilities at book
value, there is a strong likelihood that the numbers which reflect on the balance sheet are far from
their market value.
In normal course, a valuer must make necessary adjustments, however, under R. 11UA of the
Income Tax Rules, in some cases, the assets and liabilities have to be considered at book values
only. Where the various components are considered at the carrying value, the method is called
NAV method, where they are considered at the market value, they are called Adjusted NAV
method.
The NAV method is suitable for companies whose main value lies in the assets. For example, real
estate holding companies, investment holding companies, and capital-intensive operating
companies. In the context of operating companies, the value indicated by the asset approach can
be seen as the worth of a collection of revenue-generating assets. However, there are instances
where the operating company's value exceeds that of its assets, and understanding how well the
balance sheet reflects the business's income-generating ability is crucial to assessing the
appropriateness of the value determined by the asset approach.
R. 11UA refers to two different types of NAV methods, however, in both the cases, the rule has
provided for formula as per which the value has to be arrived at:
(a) Where the unlisted equity share has to be valued for the purpose of section 56(2)(viib) 1 _
Here the rule refers to NAV method, where the values of the assets and the liabilities are
taken at their book value.
(b) Where the unlisted shares are valued for purpose other than for section 56(2)(viib) 2 - Here
the rule refers to NAV method, however, requiring fair valuation of certain classes of
assets, namely – jewelry and artistic works, shares and securities, and immovable
properties.
In this chapter, we intend to discuss these two methods in detail.
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Net Asset Value Method
Net Asset Value method for s. 56(2)(viib)3
Rule 11UA prescribes the following formula for application of this method. The fair market value
of unquoted equity shares must be computed in the following manner (rule 11UA(2)(A)):
(A-L)× [PV/PE],
where,
A = book value of the assets in the balance-sheet as reduced by any amount of tax
paid as deduction or collection at source or as advance tax payment as reduced by
the amount of tax claimed as refund under the Income-tax Act and any amount
shown in the balance-sheet as asset including the unamortised amount of deferred
expenditure which does not represent the value of any asset;
L= book value of liabilities shown in the balance-sheet, but not including the
following amounts, namely:
(i) the paid-up capital in respect of equity shares;
(ii) the amount set apart for payment of dividends on preference shares and
equity shares where such dividends have not been declared before the date
of transfer at a general body meeting of the company;
(iii) reserves and surplus, by whatever name called, even if the resulting
figure is negative, other than those set apart towards depreciation;
(iv) any amount representing provision for taxation, other than amount of
tax paid as deduction or collection at source or as advance tax payment as
reduced by the amount of tax claimed as refund under the Income-tax Act,
to the extent of the excess over the tax payable with reference to the book
profits in accordance with the law applicable thereto;
(v) any amount representing provisions made for meeting liabilities, other
than ascertained liabilities;
(vi) any amount representing contingent liabilities other than arrears of
dividends payable in respect of cumulative preference shares;
PE = total amount of paid-up equity share capital as shown in the balance-sheet;
PV = the paid-up value of such equity shares;
Scope of assets
The Rule states that the assets should be considered at their book value. This is the value at which
the assets are being carried in the books of accounts of the company; whether they are being carried
at cost or fair market value will not have any bearing on this rule. The only adjustments that can
be made here are:
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Net Asset Value Method
(a) Towards taxes paid in the form of TDS, TCS or advance tax, net of refunds, if any; and
(b) Any amount shown as deferred expenditure which does not represent the value of any
asset.
Scope of liabilities
(a) Equity shares:
The scope of “liabilities” exclude paid up capital in respect of equity shares. The question
is what is the scope of “equity shares” in the present context? Does it also include
convertible instruments? The answer to that would be negative. Let us take the case of two
instruments – compulsorily convertible preference shares (CCPS) and compulsorily
convertible debentures (CCDs).
The objective of the rule is to exclude components of the balance sheet which are
permanent in nature. Like equity shares, CCPS are permanent in nature, as they will be
compulsorily converted into equity after a certain period of time. The company is not
expected to pay back the amount paid by the shareholders for acquiring such CCPS. The
holders of the CCPS do not have any claim towards, except for the dividend as and when
declared, and in case the company goes into liquidation before they are converted into
equity, the holders will not be able to claim anything from the company as a creditor.
The ITAT Delhi4 ruling in the case of Mrs. Neelu Analjit Singh vs Addl. CIT held that
preference shares are not equity shares and should be treated as liabilities for the purpose
of the Rule 11UA, and only equity shares and free reserves are allowed to be reduced from
the liabilities to arrive at the NAV. It is however, important to note that in this case, the
preference shares were non-convertible, non-cumulative preference shares, which were
redeemable. This creates ambiguity with respect to the treatment of the CCPS.
On the other hand, CCDs, even though compulsorily convertible, are liabilities for the
companies until they are converted. Therefore, should be counted as a part of “liabilities”
and not “equity shares”.
(b) Reserves and surplus:
Another important point that needs discussion is with respect to the meaning of “reserves
and surplus”. Once again, the ITAT Delhi ruling in the case of Mrs. Neelu Analjit Singh..
stated that the objective of Rule 11UA is to leave out equity share capital and “free
reserves” from the scope of “liabilities”. Free reserves refers to such reserves which can be
utilised to pay dividend to shareholders. Therefore, if we were to go by that logic, only the
following reserves shall be included in the meaning of “reserves and surplus”:
(i) Surplus
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Net Asset Value Method
(ii) General reserve
(iii) Capital reserve
(iv) Capital redemption reserve
The next question that arises here is – what about securities premium on issue of shares?
In this regard, in the case of CNR Leading Softek Pvt Ltd. vs ITO5, the AO had considered
share premium in the liability, it was held that such assumption was flawed. It was held
that:
"Rule 11UA of the Income Tax Rules which prescribes the method of determination
of fair market value of unquoted shares does not prohibit inclusion of share
premium as part of reserves and surplus. Even if the recipient company does not
justify receipt of share premium, still the fact of share premium being reflected in
the balance sheet cannot be ignored by the ld."
The tribunal further observed that,
"only such reserves set apart for depreciation would partake the character of a
liability for the purpose of determination of fair market value of shares. Hence the
share premium would be included in the ‘reserves and surplus’ even as per Rule
11UA of Income Tax Rules. While this is so, it is completely wrong on the part of
the ld. AO to ignore the same while valuing the shares of the assessee company
both under ‘liability approach’ and considering the same as a liability under ‘asset
approach’."
Based on the above, it is clear that share premium shall also form part of reserves and
surplus.
(c) Provisions:
With respect to the provisions, there rule provides for the following:
(i) Any provision for taxation, excluding tax paid through deduction, collection at
source, or as advance tax, minus the amount claimed as a refund under the Income-
tax Act, to the extent it exceeds the tax payable on book profits according to the
relevant law.
(ii) Any amount representing provisions made for meeting liabilities, other than
ascertained liabilities. Therefore, general provisions like provision for bad and
doubtful debts shall form part of this.
Illustrating the above with an example:
ABC Limited
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Net Asset Value Method
Balance Sheet
as on March 31, 2024
All figures in INR lakhs, unless otherwise stated
As at March As at March
Particulars
31, 2024 31, 2023
Assets
(I) Financial Assets
(a) Cash and Cash Equivalents 12.25 34.14
(b) Bank balances other than (a) above 2000.00 0.00
(c) Trade receivables 0.00 22.22
(d) Investments 2108.77 3054.75
(e) Other financial assets 63.00 1050.85
(II) Non Financial Assets
(a) Current Tax Asset (Net) 119.70 105.33
(b) Investment Property 6.66 6.66
(c) Other non financial assets 61.01 4.20
Total 4371.39 4278.15
Liabilities and Equity
(I) Financial Liabilities
(a) Payables
Trade payables
(i) total outstanding dues to MSMEs 0.00 0.00
(ii) total outstanding dues to creditors other than MSMEs 0.00 0.00
Other payables
(i) total outstanding dues to MSMEs 0.15 0.91
(ii) total outstanding dues to creditors other than MSMEs 5.94 6.48
(b) Other financial liabilities 0.01 0.00
(II) Non financial liabilities
(II) Equity
(a) Equity share capital 900.00 900.00
(b) Other Equity 3465.29 3370.76
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Net Asset Value Method
Total 4371.39 4278.15
Additional information:
Paid-up value of each equity share (in Rs) 10.00
Other equity includes:
(a) General reserves 600.00
(b) Retained earnings 2865.29
As suggested in the formula, there are four key elements:
Assets (A):
The first element is the assets, which are to be considered at book value, net of the adjustments
provided in the rule.
In the present case, the assets consist of Current Tax Asset, therefore, while the other assets can
be taken at book value, the Current Tax must be reduced.
Therefore,
Assets (A)
Total Asset at book value 4371.39
less: Current Tax Asset 119.70
Assets (A) 4251.69
Liabilities (L):
The next element is liabilities, which has to be taken at book value, net of the adjustments to be
made as per the rule.
Therefore,
Liabilities (L)
Total Liabilities at book value 4371.39
less: Paid up equity 900.00
less: Other Equity 3465.29
Liabilities (L) 6.10
Paid Equity (PE):
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Net Asset Value Method
The third element is the paid up value of equity as shown in the balance sheet. In the present case,
the paid equity capital is 900.
Paid-up value of equity (PV):
The last element is the paid up value of each equity share, which in the present case is Rs. 10 each.
Therefore, in light of the above, the fair value of equity shares works out to be:
A= 4251.69
L= 6.10
PE = 900.00
PV = 10.00
Fair value per share = (A-L)x(PV/PE)
or, (4251.69-6.10)X(10.00/900.00)
i.e., 47.17
Therefore, the fair value of equity share in the present case works out to be Rs. 47.17 each.
Net Asset Value method for other than s. 56(2)(x)
Where the unlisted shares are valued for purpose other than for section 56(2)(viib) - Here the rule
refers to NAV method, however, requiring fair valuation of some types of assets, as is understood
from the formula mentioned, which is as follows (rule 11UA(1)(a)(c)):
A = book value of all the assets (other than jewellery, artistic work, shares,
securities and immovable property) in the balance sheet as reduced by,
(i) any amount of income-tax paid, if any, less the amount of income-tax
refund claimed, if any; and
(ii) 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 this rule;
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Net Asset Value Method
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
following amounts, namely:—
(i) the paid-up capital in respect of equity shares;
(ii) the amount set apart for payment of dividends on preference shares and
equity shares where such dividends have not been declared before the date
of transfer at a general body meeting of the company;
(iii) reserves and surplus, by whatever name called, even if the resulting
figure is negative, other than those set apart towards depreciation;
(iv) 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, to the extent of the excess over the tax payable with reference to the
book profits in accordance with the law applicable thereto;
(v) any amount representing provisions made for meeting liabilities, other
than ascertained liabilities;
(vi) 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;]
Scope of Assets
(a) Assets to be considered at book value
The manner of arriving at the value of the assets is different here. The rule provides for
consideration of assets other than jewellery, artistic works, shares and securities and
immovable properties, at book value. Therefore, assets like plant and machinery,
receivables, intangible assets etc. would be considered at book value. Much like rule
11UA(2)(A), this also provides for adjustment of certain items from the value of the assets.
(b) Assets to be considered at their market value
Three types of assets have to be considered at market value for the purpose of this rule,
jewellery and artistic works, immovable properties, and shares and securities.
With respect to the first category, the rule requires registered valuers to determine the value
which can be fetched if sold in the open market.
With respect to immovable properties, the valuation assessed for the purpose of stamp duty,
shall be considered as the fair value.
With respect to shares and securities, the rule states that the value must be determined in
the manner prescribed in the rules. This creates the situation a bit tricky. Let us assume the
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Net Asset Value Method
company in respect of which the valuation is being conducted has made investments in the
shares of another company, then such shares must be taken at fair value. If the investments
are quoted on stock exchanges, then the process of determining the value will be simpler
(as per rule 11UA(1)). However, the situation will be different where the investment is
unlisted – the valuer will have to conduct valuation of the downstream entity as well. But
what if the downstream entity has made further downstream investments? Will the valuer
keep going or stop? In an idealistic situation, the valuer must keep going on until it reaches
the last layer of investments, however, what is ideal need not always be practical. There
could be several challenges, the most prominent one being unavailability of information.
Therefore, it is a judgmental call for the valuer to what extent it wishes to go.
Scope of Liabilities
Same as mentioned in the earlier section.
Illustrating the above with an example:
ABC Limited
Balance Sheet
as on March 31, 2024
All figures in INR lakhs, unless otherwise stated
As at
As at March
Particulars March 31,
31, 2023
2024
Assets
(I) Financial Assets
(a) Cash and Cash Equivalents 12.25 34.14
(b) Bank balances other than (a) above 2000.00 0.00
(c) Trade receivables 0.00 22.22
(d) Investments 2108.77 3054.75
(e) Other financial assets 63.00 1050.85
(II) Non Financial Assets
(a) Current Tax Asset (Net) 119.70 105.33
(b) Investment Property 6.66 6.66
(c) Other non financial assets 61.01 4.20
Total 4371.39 4278.15
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Net Asset Value Method
Liabilities and Equity
(I) Financial Liabilities
(a) Payables
Trade payables
(i) total outstanding dues to MSMEs 0.00 0.00
(ii) total outstanding dues to creditors other than MSMEs 0.00 0.00
Other payables
(i) total outstanding dues to MSMEs 0.15 0.91
(ii) total outstanding dues to creditors other than MSMEs 5.94 6.48
(b) Other financial liabilities 0.01 0.00
(II) Non financial liabilities
(II) Equity
(a) Equity share capital 900.00 900.00
(b) Other Equity 3465.29 3370.76
Total 4371.39 4278.15
Additional information:
Paid-up value of each equity share 10.00
Other Equity includes:
(a) General reserves 600.00
(b) Retained earnings 2865.29
Investments Cost Fair Value
Investments in subsidiaries - listed shares (carried at cost)
-Alpha Limited 700.00 2818.00
-Beta Limited 800.00 1575.00
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Net Asset Value Method
Investments in subsidiaries - unquoted (carried at cost)
-Charlie Limited 608.77 1789.00
Investment Property
-Investment in Immovable Property 6.66 78.00
As suggested in the formula, there are several elements in the formula.
Assets:
The first element is the assets. The assets are categorised into the following (a) those to be
considered at book value, and (b) those to be considered at the fair value.
In the present case, the following assets are to be considered at cost:
(a) Cash and Cash Equivalents
(b) Bank balances
(c) Trade receivables
(d) Other financial assets
(e) Other non-financial assets
Further, the assets consist of Current Tax Asset, which must be reduced from the book value of
above assets.
Therefore,
Assets (A)
Total Asset at book value 2255.96
less: Current Tax Asset 119.70
Assets (A) 2136.26
Next we will have to consider the financial assets which have to be considered at fair value, and
they are:
(a) Investments
(b) Investment property
In the present case, the investments have been made solely in its subsidiaries. The fair value of
such investments, in the manner prescribed under the rules, as on the valuation date have been
give. Therefore, the value of shares and securities works out to be:
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Net Asset Value Method
Shares and securities (C)
-Alpha Limited 2818.00
-Beta Limited 1575.00
-Charlie Limited 1789.00
Fair value of shares and securities (C) 6182.00
Further, with respect to the immovable property owned by the Company, the assessed value of
such as per the Stamp Duty circle rates have been given to be Rs. 78 lakhs.
Lastly, there is no jewellery or artistic works which need fair valuation.
Liabilities (L):
The next element is liabilities, which has to be taken at book value, net of the adjustments to be
made as per the rule.
Therefore,
Liabilities (L)
Total Liabilities at book value 4371.39
less: Paid up equity 900.00
less: Other Equity 3465.29
Liabilities (L) 6.10
Paid Equity (PE):
The third element is the paid up value of equity as shown in the balance sheet. In the present case,
the paid equity capital is 900.
Paid-up value of equity (PV):
The last element is the paid up value of each equity share, which in the present case is Rs. 10 each.
Therefore, in light of the above, the fair value of equity shares works out to be:
A= 2136.26
B= 0
C= 6182.00
D= 78.00
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Net Asset Value Method
L= 6.10
PE = 900.00
PV = 10.00
Fair value per share = (A+B+C+D-L)x(PV/PE)
=(2136.26+0+6182.00+78.00-
6.10)X(10.00/900.00)
93.22
Therefore, the fair value of equity share in the present case works out to be Rs. 93.22 each.
Pros and Cons of NAV method
While the methods discussed above are primarily driven by the set formula prescribed under the
law, they share the characteristics of NAV and the adjusted NAV methods. Hence, it may be
worthwhile to understand the benefits and challenges of each method.
The pros and cons for NAV method are as follows:
Pros:
1. Objective and simple: The NAV method is straightforward and objective. It relies on the
actual historical cost of assets, which is easily obtained from a company's financial
statements.
2. Transparency: The NAV is derived directly from the company's financial statements,
providing a transparent and easily accessible source of information for investors, analysts,
and stakeholders.
3. Historical cost basis: It uses the historical cost of assets, which can be particularly relevant
for industries where the market value of assets closely aligns with their historical cost (e.g.,
certain manufacturing or real estate businesses).
4. Useful for certain industries: The NAV method is more suitable for companies with
significant tangible assets, where the historical cost of assets provides a reasonable
approximation of their current market value.
5. Conservative valuation: The book value method often results in a more conservative
valuation, making it useful for risk-averse investors. This approach may be more suitable
in situations where a conservative estimate is desired
Cons:
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Net Asset Value Method
1. Ignores market conditions: The NAV method does not take into account current market
conditions, supply and demand factors, or changes in the value of assets since their
acquisition. This can lead to undervaluation, especially in rapidly changing industries.
2. No consideration for Intangible Assets: Many modern businesses derive a significant
portion of their value from intangible assets (e.g., patents, trademarks, brand value) that
are not reflected accurately in the book value. This can result in a substantial
undervaluation of the company.
3. Does not reflect the Economic Value: The NAV method may not accurately reflect the
economic value of a company, especially if the market value of assets has significantly
deviated from their historical cost.
4. Does not capture future earnings: Since it relies on historical data, the NAV method does
not consider a company's future earnings potential, growth prospects, or the value of
intangible assets that contribute to future cash flows.
5. Not forward-looking: The NAV is backward-looking and does not provide insight into a
company's future performance or potential for growth. This limitation can be significant
for investors seeking companies with growth prospects.
6. Depreciation challenges: The NAV of certain assets may be reduced by depreciation, which
might not accurately reflect the actual market value or replacement cost of those assets.
Pros and cons of Adjusted NAV method
The pros and cons of Adjusted NAV method are as follows:
Pros:
1. Fair Market Valuation: The Adjusted NAV method considers fair market values for assets,
providing a more realistic and up-to-date representation of a company's worth.
2. Relevance for Intangible Assets: Unlike the NAV method, adjusted NAV takes into
account the fair market value of intangible assets. This is crucial for industries where
intangible assets, such as intellectual property or brand value, significantly contribute to
the company's value.
3. Reflects Economic Value: By adjusting the book value to reflect fair market values, the
Adjusted NAV method is more likely to capture the economic value of the company's
assets, providing a more accurate picture of its overall value.
4. Useful in Distressed Situations: Adjusted NAV can be particularly useful in distressed
situations where the market value of assets may deviate significantly from their book
values.
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Net Asset Value Method
5. Applicability to various industries: This method is applicable to a broader range of
industries, including those with significant intangible assets or where the market value of
assets is more relevant than their historical cost.
Cons:
1. Subjectivity in adjustments: The process of adjusting the book value involves subjective
judgments. Different analysts may make different decisions about how to adjust the values,
introducing a level of subjectivity and potential variability in the valuation.
2. Complexity: The Adjusted NAV method is more complex than the basic book value
method. It requires a thorough understanding of the market conditions and the ability to
make accurate adjustments to asset values.
3. Dependence on market data: The accuracy of Adjusted NAV is dependent on the
availability and reliability of market data. In some cases, obtaining reliable market values
for certain assets may be challenging.
4. Does not capture future earnings: Similar to the basic book value method, Adjusted NAV
does not directly consider a company's future earnings potential, growth prospects, or other
factors influencing future cash flows.
5. May still undervalue intangibles: While Adjusted NAV is an improvement over the basic
book value method for considering intangible assets, there may still be challenges in
accurately valuing certain types of intangibles, leading to potential undervaluation.
6. Market conditions still important: While it addresses some of the limitations of the NAV
method, Adjusted NAV does not completely eliminate the reliance on market conditions.
If market conditions change rapidly, the adjusted values may become outdated quickly.
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