Angel Tax and its Status in India: A Comprehensive Guide for Startups and Investors

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Introduction

Hello, folks! I’m CA Bhuvnesh Kumar Goyal, a practicing Chartered Accountant and a fellow member of the Institute of Chartered Accountants of India (membership number 540126). Today, I’d like to give you the lowdown on angel tax and its status in India. This blog will provide you with the ins and outs of this tax, its impact on startups and investors, and the legal landscape surrounding it. So, buckle up and let’s get down to brass tacks!

What is Angel Tax?

Angel Tax is a term that’s been making waves in the Indian startup ecosystem for quite some time. But what exactly is it? In layman’s terms, it’s a tax levied on the capital raised by unlisted companies via the issue of shares.

A Closer Look at Angel Tax

  1. Applicable to unlisted companies only
  2. Levied on the amount raised through the issuance of shares
  3. Taxed at the rate of 30% under the Income Tax Act, 1961
  4. Exemptions and concessions are available for eligible startups

Now, let’s dive deeper into the crux of angel tax and its status in India.

Angel Tax and its Status in India: The Legal Framework

Angel tax was introduced in India back in 2012. Since then, it has been a subject of much debate and controversy. The government has taken several measures to address the concerns of startups and investors alike, but the current status of angel tax in India is still a mixed bag.

The Beginning: Section 56(2)(viib) of the Income Tax Act, 1961

Angel tax originated from Section 56(2)(viib) of the Income Tax Act, 1961. This section deems any consideration received by an unlisted company for the issue of shares as income, provided it exceeds the fair market value of said shares. Consequently, this “income” is taxed at a rate of 30%.

Revisions and Amendments: A Rollercoaster Ride

Angel tax and its status in India have gone through a series of changes over the years. Here’s a quick rundown of the major amendments:

  1. In 2016, the government introduced an exemption for startups that meet specific criteria.
  2. In 2018, the criteria for exemptions were relaxed further, benefiting more startups.
  3. In 2019, a slew of measures were announced to address the concerns of startups and investors, including the creation of a dedicated cell for addressing grievances related to angel tax.

Exemptions and Concessions for Startups

The government has been proactive in providing relief to eligible startups from the burden of angel tax. Here’s a snapshot of the key concessions:

  1. The startup must be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT).
  2. The aggregate amount of paid-up share capital and share premium shouldn’t exceed INR 25 crores.
  3. The investor must have a minimum net worth of INR 2 crores or an average income of INR 25 lakhs in the preceding three financial years.

Fair Market Value (FMV)

Determining the Fair Market Value (FMV) of shares is a crucial factor in calculating angel tax in India. It’s the value at which an asset or share would change hands between a willing buyer and a willing seller in an arm’s length transaction. Here are a few key points to keep in mind when calculating FMV:

  1. FMV can be calculated using different methods, such as the net asset value method, discounted cash flow method, and comparable sales method.
  2. The method used for FMV calculation depends on the nature of the business and the industry it operates in.
  3. It’s advisable to engage the services of a professional valuer to determine FMV accurately.

The Income Tax Department has issued guidelines on how to calculate the FMV of shares for angel tax purposes. These guidelines state that the FMV of shares can be determined based on the following factors:

  1. The value of tangible and intangible assets owned by the company
  2. The earning capacity of the company
  3. The market value of quoted shares of companies engaged in a similar line of business
  4. The net worth of the company
  5. The price-earning ratio or yield on shares of companies engaged in a similar line of business

It’s essential to note that the valuation report must be prepared by a merchant banker or a chartered accountant with a minimum of five years of experience in valuation. The valuation must be based on the latest financials of the company, and the valuation report must be obtained before the issuance of shares.

In conclusion, calculating FMV accurately is crucial in determining the angel tax liability of startups in India. Startups must ensure that they engage the services of a professional valuer to determine the FMV accurately. They must also keep themselves updated on the latest guidelines issued by the Income Tax Department on FMV calculation for angel tax purposes.

Judicial Take

In a judgement, the Delhi High Court ruled in favour of Cinestaan Entertainment, a media and entertainment company, in a move that provides startups relief from Section 56 (2) (viib) i.e Angel Tax. 

The court said that the valuation of a company through prescribed methodology and based on projected revenues cannot be challenged at a later date on the basis of actual revenues. 

FAQs on Angel Tax and its Status in India

Q1: What is the current status of angel tax in India?

A1: Angel tax is still applicable in India, but several exemptions and concessions have been introduced for eligible startups and investors.

Q2: Are all startups eligible for exemptions from angel tax?

A2: No, only startups that meet specific criteria laid down by the DPIIT are eligible for exemptions.

Q3: What is the role of fair market value in angel tax calculations?

A3: Angel tax is applicable when the consideration received for the issuance of shares exceeds the fair market value of those shares. The excess amount is considered as “income” and taxed at 30%.

Q4: Can a startup be exempt from angel tax if it has foreign investors?

A4: Yes, a startup can be exempt from angel tax even with foreign investors, as long as it meets the eligibility criteria set by the DPIIT.

Q5: Is angel tax applicable to investments made by venture capital funds (VCFs)?

A5: No, investments made by VCFs, alternative investment funds (AIFs), and specified investors are exempt from the provisions of Section 56(2)(viib).

Conclusion

Angel tax and its status in India have undergone several changes since its introduction in 2012. While the tax is still in force, the government has introduced exemptions and concessions for eligible startups to ease their burden. It’s crucial for startups and investors to stay abreast of the latest developments in angel tax regulations to make informed decisions and avoid potential pitfalls.

As a practicing Chartered Accountant, I hope this blog has provided you with valuable insights into the world of angel tax in India. If you have any further questions or require professional guidance, feel free to reach out. Remember, knowledge is power, and staying informed is the key to success in today’s dynamic business landscape.

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