What is angel tax, why was this introduced in India?

Angel tax is a tax levied on capital raised by unlisted companies. Since this was impacting investments made by angel investors in a big way, this became popularly known as ‘angel tax’. This tax provision was introduced in Finance Act, 2012 and became applicable since April 1, 2013. According to Section 56(2)(viib) of the Income-tax Act, 1961, unlisted companies receiving consideration exceeding the fair market value, for shares issued to Indian residents, are liable to pay income-tax on such excess consideration.

The objective of introducing the Section was to deter the generation and use of unaccounted money through subscription of shares of a closely held company, at a value which is higher than fair market value.

What is the change to angel tax proposed in the Union Budget? 

Prior to the Budget proposal, angel tax provisions were applicable only for investments received from resident investors. However, Finance Bill 2023 has now extended its applicability to non-resident investors as well. Consequently, premium received by unlisted company for the issue of shares (in excess of fair value) from non-residents, would also be taxed in the hands of the company.

What are those opposed to these changes saying?

While FEMA guidelines prohibit a company from issuing shares at a value below fair value, the newly proposed provisions seek to tax the transaction if the shares are issued above the fair value. Hence while section 56(2)(viib) (angel tax provisions) prescribes for an upper ceiling beyond which the price received for issue of shares will become taxable, FEMA guidelines provides for the floor price below which shares cannot be issued to non-residents. We have illustrated the issue by way of an example:

Book value – ₹70

DCF value per share – ₹100

Valuer as per internationally accepted pricing methodology – ₹135 (floor price under FEMA)

Cap on valuation under 56(2)(viib) – ₹70 or ₹100 at the choice of taxpayer. Transaction value – say ₹145 (because it can be any price above 135 under FEMA). While the transaction value of ₹145 is permissible from FEMA perspective, under section 56(2)(viib), this will result in a taxable income of ₹45 (₹145 less ₹100) which will be taxed at ordinary corporate tax rates. Hence the proposed provisions will result in irreconcilable difference in value for equity shares.

Is angel tax hurting fund-raising by start-ups?

Start-ups which are registered with the Department of Promotion of Industry and Internal Trade are excluded from the purview of angel tax provisions.

Accordingly, such eligible start-ups will not be impacted by the amended angel tax provisions. However, there are many unregistered start-ups and  hence this provision has a potential to significantly impact capital flows to start-ups and foreign direct investment in general.

The writer is Partner Deloitte India