Angel Tax Provisions for Indian Startups
Unlisted Indian startups are subject to an angel tax on investments raised by them through the issuance of equity shares and cumulative convertible preference shares. The tax is applicable when the issuance price is more than the fair valuation of the shares. The Indian tax authorities have spelled out the rules for the taxing of the valuation of shares issued by startups to resident as well as nonresident investors.
What is Angel Tax?
Angel tax of 30.6% is a tax that unlisted startups may be liable to pay on the funds
raised by them through the issue of shares at a price higher than the fair value.
The tax is not on the entire investment but only the amount that is considered above fair value, under the head of income from other sources in the Income Tax Act of India. The tax originally imposed only on investments made by resident investors is now applicable to non-resident investors too.
Tolerance Range
The tax authorities now allow for a 10% tolerance range which means if the issue price of unquoted equity shares or CCPS is within 10% of the price determined by any of the valuation methods, it is considered as the fair market value. This deviation allowance can help startups deal with the impact of foreign exchange fluctuations, variations in bidding, and other factors. Most of the venture fund investments in Indian startups are through the CCPS.
Why Was It Introduced?
The tax was introduced in 2012 to plug money laundering practices and since its impact rested on angel investors who are putting in their money in a startup, it iscalled an angel tax. Concerns about being subjected to unnecessary income tax scrutiny have been raised by many startups which the authorities say can be avoided by filing the required declarations and returns.
Exemptions
The startups that are registered under the Department for Promotion of Industry and Internal Trade or DPIIT are exempt from angel tax. Also, the government in May 2023 announced exemptions for investors from 21 countries including the US, UK, and France from the ambit of angel tax for non-resident investors in Indian startups. However, investments from popular countries like Singapore, the Netherlands, and Mauritius were excluded from this list.
Methodology for the Calculation of Fair Value
The startups need to determine their angel tax incidence under Section 56(2) (vii)
(b) of India’s Income-tax Act 1961. The CBDT had specified two methods for the valuation of the unquoted shares for resident investors:
1) Discounted Cash Flow or DCF
2) Net Asset Value or NAV
These methods are applicable to non-resident investors too who have the choice of five more valuation methods namely:
1) Comparable Company Multiple Method
1) Probability Weighted Expected Return Method
2) Option Pricing Method
3) Milestone Analysis Method
4) Replacement Cost Method.
The fair market value determination is tied to the timing of the consideration receipt. If the consideration for shares is received within a 90-day period before the issuance of the shares the price at which they were issued to non-resident investors and venture capital funds or specified funds is recognized as the fair market value.
