Recent developments on the levy of an angel tax follows a pattern established by more illustrious Sections of the Income Tax Act — a hazily-worded provision, tax notices being received misinterpreting the provision, and protests resulting in the issue of a clarificatory Notification that provides some relief but doesn’t resolve the issue once and for all.

Section 56(2)(viib) of the Income Tax Act (the angel tax Section), seeks to tax the difference between the fair market value and the face value of shares received by a company. While this appears simple and logical, an Explanation to the Section that attempts to define fair market value ends up with a definition that would probably not qualify to be called a definition — higher of the value as may be determined in accordance with such method as may be prescribed or as may be substantiated by the Company to the Assessing Officer.

The entire angel tax issue can be attributed to this Explanation — such method as may be prescribed could mean any value in the absence of specific prescriptions. The possibility of companies substantiating their valuation to an Assessing Officer is a no-brainer as companies would attempt to substantiate their valuation on Excel Sheets while Assessing Officers would look for valuation guidance in the Income Tax Act/Rules (both of which don’t provide any guidance).

DIPP Notification

As protests from a bunch of start-ups grew, the Department of Industrial Policy and Promotion (DIPP) came out with a Notification that does away with the need to obtain an approval from an Inter-Ministerial Board and the need for a Valuation Report from a merchant banker.

The DIPP Notification states that it would apply only to start-ups with paid-in capital and share premium not exceeding ₹10 crore. Also investors/proposed investors should have returned income of ₹50 lakh or more for the financial year preceding the year of investment/proposed investment, and a net worth exceeding ₹2 crore or the amount of investment proposed, whichever is higher. Section 56(2)(viib) is applicable to a company — in attempting to link the numbers declared in the investors’ tax returns to this Section, the CBDT is stepping into unwanted territory.

Investors would be wary of providing this data to start-ups which could delay the funding process. Investors normally invest in a basket of start-ups to ensure that the losses on their investments which a majority of start-ups are bound to incur are made up by the profits from a couple of multi-bagger start-ups. Such investors would be in a dilemma whether they meet the criteria or not.

While the Notification can solve some of the issues being faced by start-ups, it is not a holistic solution. Since this has been issued by the DIPP, it would apply only to start-ups that are registered with DIPP as a part of the Start-up India initiative. There are a large number of mom-and-pop start-ups that would not have registered with the DIPP. Some of these could get funding in excess of ₹10 crore and could still have to face valuation notices from the Tax Department.

Since the issue of angel tax emanates from an Explanation to a Section in the Income Tax Act, a clarificatory Notification should come from the CBDT that applies to the entire population of start-ups. The CBDT should also amend ICDS Standards and bring them on par with Ind AS Accounting Standards which have some definition of fair value. Till such time, implementation of the angel tax section should be deferred.

The writer is a chartered accountant

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