Angel Tax Norms: Changes since 1 April 2023

Section 56(2)(viib) of the Income Tax Act, 1961 states that the considerations received by companies from a resident that is more than the Fair Market Value (FMV) of the shares issued shall be liable to taxation in the hands of such companies.

This provision was added to the Income Tax Act by the Finance Act, 2012 with the aim of preventing the flow of unaccounted money as share premium - this is commonly referred to as ‘Angel Tax.’ Considering non-resident investors have more compliances to adhere to under exchange control and need certain registrations in a foreign country, investments made by such individuals are kept out of the provisions of angel tax. Although this section’s provisions apply to the issuance of all types of shares, issuance of instruments such as convertible debentures are not affected by the above-mentioned provisions.

While it was expected that by repealing Angel tax the government would provide some relief to resident investors, the government actually aimed to bring equivalence in taxation by extending the applicability of these provisions to non-residents.

The Finance Bill, 2023, now, suggests to remove this section’s residency-requirement and make it applicable even when non-resident investors are issued any shares. It must be noted that this amendment shall only affect shares issued and premium received on or after 1 April 2023.

The pricing guidelines of foreign exchange in India dictate that the shares issued to any non resident investor cannot be valued below the FMV of the share. Angel tax aims to now tax any consideration received by a company that is more than the FMV of the share as ‘income.’ As such, the only viable option for companies would be to buy shares at the exact FMV of the share to ensure, which would basically have a significant effect on price negotiations during an investment.

This amendment may actually lead to foreign investors refraining from investing in India and encourage startups to consider planning their holdings overseas to avoid any pressure from relevant foreign investors. Regardless, the Government of India introduced some measures to enable and encourage foreign investments in Indian companies.

The exemptions provided under this Section shall only be available for recognized startups that issue shares to both resident and non-resident investors. In addition, investments in Indian companies through certain funds like Alternative Investment Funds (AIF) would fall within the scope of this section.

Note: Startups that have filed a declaration in Form-2 with the Department for Promotion of Industry and Internal Trade (DPIIT) are referred to as ‘registered startups.’

Exclusion of Certain Categories of Investors

The Central Board of Direct Taxation’s (CBDT) notification no. 29/2023 (Notification 1) excludes the following categories of investors from the ambit of Angel Tax provisions:

Government Category

• Government,
• Investors associated with the Government, such central banks, sovereign wealth funds, etc.,
• Entities that are under the control of the Government, or
• Entities where 75% or more is owned by the Government, be it directly or indirectly.

Banking & Insurance Category

• Banks, or
• Any entity involved in the insurance business, where the said entity falls within the scope of the applicable regulations in the country where it was established, incorporated or is a resident.

Entities from Specific Jurisdictions

• Any of the following entities where residents of any country or specified territory listed in Annexure to Notification 1 and such entity is subject to relevant laws in the country in which it is established or incorporated as a resident:
• Any entity registered with Securities and Exchange Board of India (SEBI) as Category-I foreign portfolio investors.
• Endowment funds related to universities, hospitals or any charity.
• Pension funds created/established in accordance with any statute of the foreign country or defined category.
• Board-based pooled investment vehicle/fund that has more than 50 investors and not a hedge fund or any fund that involves diverse or intricate trading strategies.

Following 21 countries are mentioned in the Annexure to the Notification 1:

Australia	Austria	Belgium
Canada	Czech Republic	Denmark
Finland	France	Germany
Iceland	Israel	Italy
Japan	Korea	New Zealand
Norway	Russia	Spain
Sweden	United Kingdom	United States

It must be noted that this notification did not include investments from countries such as Singapore, Netherlands and Mauritius.

Relaxation for Startups

• Before, if startups comply with the circumstances defined by the DPIIT at para 4 of DPIIT Notification No. S.O. 1131 (E) 2019, the CBDT Notification No. 13 of 2019 exempted them from the ambit of angel tax provisions. However, to claim this exemption, startups must file a self-declaration mentioning that the eligible startup does not have any investment in any non-qualifying assets.

Note: DPIIT must transmit this self-declaration to the CBDT.

• As the shares issued to residents was earlier under the scope of the Angel tax laws, startups issuing shares to resident investors at a premium were exempted by the CBDT Notification No. 13/2019.
• CBDT issued Notification No. 30/2023 offers exemption to startups on shares issued to any individual - resident or non-resident investor - on same conditions as per what was applicable with respect to resident investors.
• This notification (Notification No. 30/2023) came into effect from 1 April 2023. As such, any investment made by non-resident investors in DPIIT registered startups that fulfill the specified conditions shall be covered by it from 1 April 2023.

Conclusion

Besides, to levy income tax, the CBDT is expected to release valuation guidelines for valuing investments by non-residents in non-registered startups. As per the existing standards, only the investments made by any domestic investor or resident in some closely held company were taxed for the amount that was over and above the FMV. This was generally known as ‘Angel Tax.’ However, now, the residency aspect has been entirely removed from this section, creating a certain level of equivalence in this regard.