26 May 2023

Angel Tax: A proposal for reforming valuation rules


To deter generation and use of unaccounted money through subscription of shares of a closely held company, Finance Act, 2012 introduced Section 56(2)(viib) in the Income Tax Act, 1961 (‘IT Act’). The aforesaid section provided that where a closely held company receives consideration from resident investors for issue of shares at premium in excess of the fair market value (‘FMV’), then the excess consideration will be taxed as ‘income from other sources’ in the hands of the issuing company. As this provision had potential impact on angel investors in a start-up, it was colloquially referred to as ‘Angel Tax’.

The Finance Act 2023 extended the ambit of Angel Tax to even non-resident investors. Considering the challenges posed by the aforesaid amendment, the CBDT has issued a press release on 19 May 2023 proposing certain legislative changes. It may be reiterated that the exact text of the draft legislative changes is yet to be released in public domain for comments. These proposals are detailed below:

Reforming Rule 11UA

  • Alternate valuation methods for non-resident investors
    • Presently, issuing company are given the option to determine FMV of equity shares by Net Asset Value method or Discounted Cash Flow (‘DCF’) In addition to aforesaid, it is now proposed to add five more valuation methods for non-resident investors.
  • Consideration received from notified entity deemed as FMV
    • When a company issue shares to notified non-resident entities, the issue price of such shares shall be deemed to be FMV for resident as well as non-resident investors subject to certain conditions.
    • Similar price matching facility for resident as well as non-resident investors would also be available with respect to investment made by Venture Capital Funds and Alternative Investment Funds[1].
  • Relaxation in valuation date for merchant banker’s valuation report
    • DCF method of valuation needs to be mandatorily supported by a valuation report obtained from a merchant banker. Under the existing provisions, the valuation date is prescribed as the date when the company issuing shares receives the consideration.
    • It is now proposed that report of merchant banker which is obtained prior to prescribed valuation date will be acceptable if the gap between the actual valuation date and the prescribed valuation date does not exceed 90 days.
  • Safe harbor threshold introduced
    • In order to safeguard the taxpayers from variation in FMV and issue price on account of certain uncontrollable factors like forex fluctuations, bidding processes and other economic indicators, it is proposed to provide a safe harbor of 10% variation in value. Thus, there would be no Angel Tax implications on the companies where the variation between the actual consideration and the FMV is up to 10%.

Exclusion of certain non-resident investors from Angel Tax provisions

It is proposed to notify following non-resident entities, which will be excluded from the scope of Angel Tax:

  • Government and Government related investors such as central banks, sovereign wealth funds, international or multilateral organizations or agencies including entities controlled by the Government or where direct or indirect ownership of the Government is 75% or more.
  • Banks or Entities involved in Insurance Business which are subject to applicable regulations in the country where it is established or incorporated or is a resident.
  • Any of the following entities, which is a resident of a certain countries or specified territories having robust regulatory framework:
    1. Entities registered with Securities and Exchange Board of India as Category-I Foreign Portfolio Investors.
    2. Endowment Funds associated with a university, hospitals, or charities.
    3. Pension Funds created or established under the law of the foreign country or specified territory,
    4. Broad Based Pooled Investment Vehicle or Fund where the number of investors in such vehicle or fund is more than 50 and such fund is not a hedge fund or a fund which employs diverse or complex trading strategies.

No Angel Tax on non-residents investing in eligible Start-ups

CBDT notification dated 05 March 2019 exempted eligible start-ups receiving consideration for issue of shares from ‘resident person’ from the applicability of Angel Tax. Since the Angel Tax provisions are now made applicable to non-resident investors, it is proposed to modify the aforesaid notification and provide that eligible start-ups receiving consideration from ‘any person’ will not be subject to Angel Tax.

Way Forward

The changes proposed by CBDT are appreciable and will bring a huge relief for the issuing company especially where funds are raised from non-resident investors. Introduction of safe harbor rule and relaxation in obtaining merchant banker’s report prior to valuation report fixes the practical challenges, which are usually being faced by the taxpayers in relation to valuation of instruments. Further, introduction of the concept of Deemed FMV will reduce disputes around the valuation process greatly. The CBDT will shortly roll out draft rules which will be open for public comments for 10 days. It would be great to see the new valuation methodologies which will be notified for non-resident investors and their alignment with the valuation methodology prescribed under the Foreign Exchange Management Act.


[1] which is  regulated under Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012 or under International Financial Services Centre Authority (Fund Management) Regulations, 2022)

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