Navigating Angel Tax in India: Regulations, Exemptions, and Recent Amendments

Key Takeaways

1. What is Angel Tax?

Angel tax is the tax paid by unlisted companies on gaining funding from angel investors through issuing shares. It is applicable when the consideration for the shares exceeds the fair market value.

2. Who are Angel Investors?

Angel investors are wealthy individuals who invest their personal income in business start-ups or small and medium scale companies. They differ from venture capital firms as they invest their own money.

3. Applicability of Angel Tax

Tax is levied only on the premium amount received by the company, which is the difference between the face value of the shares issued and the actual value of the shares.

4. Angel Tax Exemptions

Startups are exempt from paying angel tax subject to conditions such as recognition by the Department for Promotion of Industry and Internal Trade (DPIIT) and a total paid-up capital of less than or equal to 25 crores.

5. Rates of Angel Tax in India

The angel tax is levied at the rate of 30% in India, with an additional cess of 3% applicable to it.

6. Recent Amendments to Valuation of Companies for Angel Tax

The Central Board for Direct Taxes (CBDT) issued a notification providing additional flexibilities in the fair market value (FMV) valuation rules for angel tax provisions, including new valuation methods, price matching for resident and non-resident investors, and a “safe harbor” clause.

7. Impact of Angel Tax

The amendment to Section 56(2)(viib) aims to regulate share premium of a company by taxing the capital generated by the company through the sale of shares at a price higher than the market price. The relief from this section is available for recognized startups meeting specific conditions.

Synopsis:

The provisions relating to angel tax in the Income Tax Act, 1961 were primarily introduced to regulate funding received by unlisted companies from angel investors and specifically, to curb money laundering and funneling of black money into the start-up ecosystem. Originally, under section 56(2)(viib) of the IT Act, an unlisted company receiving any consideration for the issue of shares exceeding the face value of such shares from any resident person, where the aggregate consideration received for such shares exceeds the fair market value (FMV) determined in accordance with Rule 11UA of Income Tax Rules, was liable to tax in the hands of such company as ‘income from other sources’. This provision, commonly referred to as ‘angel tax’, was inserted by the Finance Act, 2012 to prevent the circulation of unaccounted money as share premium.

Angel tax is the tax paid by unlisted companies on gaining funding from angel investors through issuing shares. The companies doing very well operationally use their brand value to get funding and issue shares at a price more than its fair market value. The company’s excess earnings are considered income from other sources.

Angel Investors generally refer to wealthy individuals who make investments in up-and-coming startups to obtain equity ownership. They are different from venture capital firms because they invest their own money. Therefore, the tax levied on their investment is called an Angel Tax. Such tax is not levied on foreign investors or venture capital funds/companies.

The tax is levied only on the premium amount received by the company. In simple words, the difference between the face value of the shares issued and the actual value of the shares is calculated and taxed at the applicable rate.

Earlier, the consideration received in the form of angel investment was chargeable to tax under section 56(2)(viib) under the ‘Income From Other Sources’ head. However, the Indian government brought about exemptions in Angel Tax for startups in 2019 to encourage ease of doing business. Startups are now exempt from paying angel tax subject to certain conditions, such as being recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), having a total paid-up capital of less than or equal to 25 crores, and receiving angel investment from foreign investors.

The angel tax is levied at the rate of 30% in India, and an additional cess of 3% is also applicable to it as per section 56(2)(vii)(b) of the Income Tax Act, 1961. The effective rate of the angel tax is 30.9%.

Recent amendments to the valuation of companies for angel tax have provided additional flexibilities in the FMV valuation rules, including new valuation methods, price matching for resident and non-resident investors with reference to investments by VCs or specified funds, and a “safe harbor” clause allowing for a 10% variation between the valuation price and issue price.

The impact of angel tax has been significant, with startups facing challenges in justifying the value of shares and spending time dealing with tax authorities. Relief from Section 56(2)(viib) is available for startups that fulfill certain conditions and are recognized under relevant notifications.

In conclusion, the changes in the tax laws related to Angel Tax have aimed to ease the burden for startups and motivate wealthy individuals to invest in innovative business models. However, concerns remain regarding the impact of these changes on the start-up ecosystem in India.

FAQ

Q1: What is the Applicability of Angel Tax?

A1: Tax is levied only on the premium amount received by the company, which is the difference between the face value of the shares issued and the actual value of the shares.

Q2: What are Angel Tax Exemptions?

A2: Startups are exempt from paying angel tax subject to conditions such as recognition by the DPIIT and a total paid-up capital of less than or equal to 25 crores.

Q3: What are the Rates of Angel Tax in India?

A3: The angel tax is levied at the rate of 30% in India, with an additional cess of 3% applicable to it.

Q4: What are the Recent Amendments to Valuation of Companies for Angel Tax?

A4: The recent amendments provide additional flexibilities in the FMV valuation rules for angel tax provisions, including new valuation methods, price matching for resident and non-resident investors, and a “safe harbor” clause.