Indian Startups’ Tussle With Angel Tax Remains Unaddressed

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Finance Bill, 2023 has been passed with some significant amendments, including the taxation of debt funds. However, it is unfortunate that the concerns of Indian startups regarding the angel tax provisions have not been addressed. It is interesting to note that the tax regime has now been extended to non-resident investors by omitting the term “resident” from Section 56(2)(viib) of the Income Tax Act. This section deals with the provisions of angel tax, which requires unlisted companies to pay tax on capital raised if the shares’ value issued to investors exceeds their fair market value.

On the other hand, if the share value is less than the fair market value, then the difference between the two is considered as “income from other sources” for angel investors, making them liable to pay tax. As per the Income Tax Act, a tax of 30.9% is imposed on the share premium issued by unlisted or closely held companies. It remains to be seen how these changes will impact Indian startups and non-resident investors and whether any further amendments will be made to address their concerns. There is some uncertainty around the impact of the proposed amendment to Section 56(2)(viib) of the Income Tax Act, which deals with angel tax. The amendment proposes to remove the preferential treatment for foreign investors, which could potentially lead to overseas investors being subject to angel tax. However, according to the DPIIT secretary, the amendment will not impact DPIIT-recognised startups, so it is possible that the impact of the amendment will be limited. Nevertheless, it appears that the amendment will apply to all classes of shares, not just equity.

Some experts believe that the impact of the amendment will be similar to the impact of angel tax on startups when it was first introduced in 2012. Others have noted that there is a dichotomy between the valuation rules under the FEMA regulations and the Income Tax Rules, which could create some confusion and uncertainty. Overall, it seems that the impact of the proposed amendment to Section 56(2)(viib) is still unclear and will depend on a number of factors, including the interpretation of the relevant provisions by tax authorities and the specific circumstances of each case.