Introduction: This article clears the position of startups as regards the applicability of angel tax.
Background: Clause (viib) of subsection (2) of section 56 was inserted vide Finance Act, 2013 w.e.f. 01.04.2013 i.e. for A. Y. 2013-14 where a closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares will be charged to tax in the hand of the company as income from other sources.
The fair market value of the unquoted equity shares is determined as per the discounted cash flow method, by Chartered Accountant or merchant banker as per Rule 11UA(2)(b) of Income-tax Rules 1962. However, such valuations are not being accepted or rejected/ modified by the assessing officer invariably.
Definition of Startups: The Government of India has defined ‘Startup’ through notification in the Gazette of India no. G.S.R. 180(E) dated February 17, 2016. Later the notification was superseded by another notification no. G.S.R.501 (E) dated May 23, 2017 thereby the definition of Startup was expanded. Accordingly, an entity incorporated after April 01, 2016 shall be considered as startup subject to fulfillment of other conditions described in notification no. G.S.R.501 (E) dated May 23, 2017.
What is ‘Angel tax’? The phrase Angel tax is not a term in the Income-tax Act. It is levied on investments made in unlisted firms at valuations considered higher than the fair market valuation (as per Section 56(2)(viib)of the Income tax Act). The tax was introduced as an anti-abuse provision as the government sought to stop the practice of issuing of shares in unlisted companies at a high premium for conversion of black money into white.
Exemption from Angel tax: The CBDT had on June 14, 2016 issued a notification no. 45/2016, F.No. 173/103/2016-ITA-I amending Section 56(2)(viib) to exempt only those startups that have got certified themselves by the department of industrial policy and promotion (DIPP) in 2016 or afterward.
Latest Circular by CBDT: To protect start-ups from aggressive tax demands, the income tax (I-T) department on February 6, 2108 (vide circular no. F.No.173/14/2018-ITA.I) stayed all recovery proceedings of the so-called ‘angel tax’ against start-ups that come under the definition put out by the department of industrial policy and promotion (DIPP) and got certified in 2016 or after.
The department of revenue has directed assessing officers that “no coercive measure to recover the outstanding demand would be taken” in cases where additions have been made to the income on account of high valuations provided that the start-ups fall within the start-up definition of DIPP. Further, the notification has directed speedy disposal of pending appeals by 31 March 2018.
Funding from Venture capital funds- Venture capital funds have been excluded from this tax by virtue of proviso to section 56(2)(viib).
Funding from Non-residents- Section 56(2)(viib) applies only to residents of India, therefore, funding from non-residents does not come in the ambit of this section.
Pre-2016 startups may get relief: The DIPP may examine the genuine cases of valuation for startups pre-2016. As per article published in ET dated February 06, 2018-Startups incorporated before 2016 that have got up to Rs 10 crore in angel funding won't face the so-called angel tax, once changes in the regime are finalized by the Department of Industrial Policy and Promotion (DIPP).
Conclusion: Startups can be of two types-
1. Registered with DIPP- Exempt from angel tax under section 56(2)(viib) by virtue of notification no. 45/2016, F. No. 173/103/2016-ITA-I issued by CBDT dated June 14, 2016 read with the notification issued in Gazette no. G.S.R. 180(E) on February 17, 2016 superseded by notification no. G.S.R.501 (E) dated May 23, 2017 and latest circular no. F.No.173/14/2018-ITA.I dated February 6, 2108.
2. Not registered with DIPP- Angel tax is applicable.
Disclaimer: This article is provided for information purposes only it could not be considered as legal or financial advice.
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