The 2023 Finance Bill has proposed to include non-resident investors in unlisted companies under the Income Tax Act’s Section 56(2)(viib), commonly referred to as the “Angel Tax.” This proposal could result in extra tax obligations for startups and privately held firms that issue shares to foreign investors at a premium value.
What is Angel Tax?
- Angel Tax refers to the income tax levied on the capital raised by unlisted companies through the sale of shares at a price higher than their fair market value.
- The extra amount is considered income and taxed accordingly.
- The term “angel tax” is derived from the fact that it mostly affects angel investments in startups.
What has the Budget Proposed?
- The Finance Bill, 2023 proposes to bring non-resident investors in unlisted companies under the ambit of Section 56 (2) (viib) of the Income Tax Act.
- The provisions will apply to all individual foreign investors. There is a need for further clarity on whether it will also apply to foreign investors structured as funds and institutional investors.
- The changes to the angel tax provisions will become effective from April 1, 2024 and will be applicable from assessment year 2024-25 onwards.
History of Angel Tax
- Angel Tax was first introduced in the 2012 Union Budget by then finance minister Pranab Mukherjee under the UPA-II regime.
- In April 2018, the government issued a notification to give exemption to startups under Section 56 of the Income Tax Act in cases where the total investment including funding from angel investors did not exceed Rs 10 crore.
Impact on Startups
- Under the rule, any premium paid by an investor in excess of the fair market value (FMV) of an unlisted company is subject to a 20% tax.
- To avoid this tax, startups may be forced to maintain a more linear valuation path and ensure there are no large swings in valuations between different rounds of funding.
- The bulk of Indian startup capital comes from foreign funds, and until now, the FMV restriction did not apply to shares sold to foreign investors.
Industry View
- Industry players and experts view the inclusion of offshore VC funds as non-residents for angel tax as creating a sense of uncertainty and fear in the minds of Indian entrepreneurs.
- There may be a tax liability for Indian companies and the revenue authorities may question the valuation reports more often.
- The government needs to clarify the issue quickly to prevent confusion and uncertainty.
Conclusion
The 2023 Finance Bill’s proposed changes to the angel tax provisions could result in additional tax obligations for startups and privately held firms that issue shares to foreign investors at a premium value. The industry and experts view this as creating uncertainty and fear in the minds of Indian entrepreneurs, and the government needs to clarify the issue quickly to prevent confusion and uncertainty.
