Angel Tax: Tax on consideration received above FMV of a shares + Exemption in Valuation Report for Startups under IT

What Is Angel Tax?

Angel tax is a term used to refer to the income tax liability on funds raised by unlisted companies/start-up companies via the issue of shares where the share price is over the fair market value [FMV] of the shares sold. The excess realisation is treated as income and taxed under section 56(2)(viib) of the Income tax act. It mostly happens where angel investor investing in the early stage or seed stage in the company hence it called “Angel Tax”

As per Section 56(2)(viib) of IT act, where a private company receives any consideration from any person being a resident, for the issue of shares that exceeds the face value, the consideration received for such shares above FMV shall be chargeable to income tax under income from other sources.

Income tax department began issuing notices to start-ups and unlisted companies demanding tax on the amount of excess share premium [price at which shares allotted minus fair market value]

What is the fair market value [FMV]?

As per Rule 11UA(2), the FMV can be determined under Net Asset Value Method (as prescribed under Rule 11UA(2)(a)) or value determined by Category I – Merchant Banker as per discounted cashflow method [DCF], at the option of the assessee or Value as may be substantiated by the company to the Assessing Officer satisfaction, based on the value, on the date of issue of shares, of its assets, including goodwill, know-how, intangible assets being copyrights, patents, trademarks or any other business or commercial rights.

How to get an angel tax exemption?

The company should only be a private limited company which is recognized as eligible start-up by the Department of Industrial Policy and Promotion (DIPP). The application for approval has to be made to the Board in the Form-2 along with the necessary documents/declaration specified therein. The startup does not invest in specified assets [mentioned below]. The Board may, after calling for such documents or information as it may deem fit, either grant approval or decline

The startups should meet following criteria

• Private Limited Company
• Aggregate amount of paid-up share capital and premium of startup after issue of share does not exceed INR 25 Crore rupees.
• Does not invest in specified assets.

Investments into eligible startups

• by listed companies with a turnover above INR 250 crore or net worth above INR 100 Crore shall be exempt under section 56(2)(viib) of the Income Tax Act.
• by Accredited Investors, Non-Residents, AIFs (Category I), & listed companies with a turnover above INR 250 Crore or net worth above INR 100 crores, shall be exempt under said section of IT.

Section 56 (2)(viib) shall not apply where the following entities received the consideration for the issue of shares

• from a venture capital company to a venture capital undertaking or a venture capital fund
• Category I or II [AIF] Alternative Investment Fund registered with SEBI

What are the specified assets where Start-ups does not invest?

It has not invested in any of the following assets,─

• building or land appurtenant thereto, being a residential house, other than that used by the Startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
• land or building, or both, not being a residential house, other than that occupied by the Startup for its business or used by it for purposes of renting or held by it as stock-in trade, in the ordinary course of business;
• loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is substantial part of its business;
• capital contribution made to any other entity;
• shares and securities;
• a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
• jewellary other than that held by the Startup as stock-in-trade in the ordinary course of business;
• any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-clauses (iv) to (ix) of clause (d) of Explanation to clause (vii) of sub-section (2) of section 56 of the Act.

Is a Valuation Report from a Merchant banker required?

The question that may arise is valuation report is required for eligible start-ups who are taking the angel tax exemption. Our take is that a valuation report is not required and, in some cases, we have to substantiate FMV to the satisfaction of AO which can be done through a Valuation Report.

Reach us

For a better understanding & discussion of how this issue might affect your start-up, please contact nexpective advisors