Provision called “Angel Tax,” from Section 56(2)(viib) of Income Tax Act, 1961, has stirred debate since 2012. It taxes shares issued by unlisted Indian companies to residents at prices above Fair Market Value (FMV). Extra premium is “Income from Other Sources,” leading to big tax bills for startups,even for legitimate fundraising.
FMV methodology has evolved over years to better match startup financing realities. Before Finance Act 2017,FMV mainly used Discounted Cash Flow (DCF) method. Early-stage startups,often with negative cash flows,got undervalued.
Government introduced safe harbour rule post-2017 to tackle this. If share price didn’t exceed FMV set by Sebi-registered merchant banker,it was accepted. Shares priced above face value but below FMV were safe too. But if price topped FMV under Rule 11UA (e),including Net Asset Value (NAV),it got taxed.
Recent changes in 2023 refined FMV process. Government saw NAV method didn’t fit knowledge-based businesses with high intangible,low tangible assets. So,revised Rule 11UA removed NAV for unlisted firms.
Now,FMV determined by two methods in Rule 11UA . First involves getting valuation from merchant banker,using global pricing methods suited to industry,company stage . Could include DCF,NAV,market price methods.
If company skips merchant banker,FMV calculated This looks at total assets minus liabilities,adjusted by ROI. ROI comes from latest arm's-length investment in company . Adjusted net value multiplied by ROI gives FMV per share.
To keep ROI method from inflating values, Rule 11UA excludes goodwill,accumulated losses,unabsorbed depreciation,and specific reserves from asset,liability calculations.
Angel Tax exemptions exist under certain conditions. Companies recognized by Department for Promotion of Industry and Internal Trade (DPIIT) are exempt if total paid-up share capital,share premium stay under ₹25 crores after offering. Also, Central Board of Direct Taxes (CBDT) lists sectors like manufacturing,infrastructure,AI for exemptions if they meet ₹25 crore cap.
Section 50CA ties to Section 56(2)(viib),covering tax impact for investors. If shares issued above FMV,excess premium is taxable for issuer. Section 50CA treats issue price as “sale consideration” for investor,possibly triggering capital gains tax on notional premium,even if shares unsold.
FMV evolution under Section 56(2)(viib) shows shift from rigid asset-heavy calculations to flexible framework. Government’s tweaks aim to curb tax dodging while supporting startup funding. Companies must navigate complexities to dodge tax fights…
