In the recently presented Union Budget 2023, it has been proposed to expand the applicability of Section 56(2)(viib) of the Income-Tax Act, 1961 (the Act), commonly referred to as Angel Tax Provisions, to the issue of shares by a closely-held company to non-resident investors. Thus, the provisions of Section 56(2)(viib) of the Act are intended to apply to the receipt of consideration from any person, irrespective of their residential status. Expectedly, there has been a lot of discussion on the impact that this change would have on the flow of Foreign Direct Investments in India, the start-up ecosystem, and the investment fraternity in general. In this article, we have delved into the various nuances of these provisions.
Section 56(2)(viib) was introduced to combat the generation and circulation of unaccounted money received by a closely-held company through share premium without being backed by appropriate valuations justifying the same. Where a closely-held company issues shares at a premium, the consideration exceeding fair market value is deemed as income in the hands of the company.
The mechanisms for computing the Fair Market Value (FMV) have been prescribed under Rule 11UA of the Income Tax Rules, 1962 (the Rules).
It is pertinent to note that the section covers all types of shares and is not limited to the issuance of equity shares. Thus, the issue of preference shares would also get covered under this provision irrespective of the fact as to whether the shares are convertible or not.
While this provision was introduced as an Anti-Tax Avoidance tool and applicable to all closely-held companies, it became widely known as 'Angel Tax Provisions' with the growth of start-ups in India. It was called Angel Tax as it impacted investment by Indian angel investors- HNIs and family offices who invested in start-ups. This tax was applicable on start-ups who raised funds from angel investors in cases where share issue prices exceeded the value determined as per the valuation method prescribed under the Rules. Hence, start-ups often found themselves in the middle of tax litigations with revenue authorities over disputes on share valuations. In other words, the Angel Tax proved to be a major deterrent to start-up investments.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
