Who is exempt from the angel tax?

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angel tax

Section 56 of the Income Tax Act, 1961 (ITA) seeks to tax “income from other sources” of a taxpayer. Section 56(2)(viib) levies tax on a private company on issuance of shares, if such shares are issued at a price higher than their fair market value. The provision exempts situations where the consideration is received by: (a) a non-resident; (b) a venture capital undertaking from a venture capital company or fund; or (c) a company from a class, or class of persons, notified by the central government.

The provision proved particularly egregious to startups and early-stage companies with limited capital, which would be required to part with a significant portion of funds obtained by them from investors in lieu of equity – hence the phrase “angel tax”. The government has issued various notifications time and again under exemption (c), mentioned above, to provide thrust to the startup ecosystem.

To further streamline the assessment process for startups seeking exemption from applicability of section 56(2)(viib) of the ITA, and with a view to ease the process of assessment for these startups, the Central Board of Direct Taxes (CBDT) has prescribed the following procedure:

  1. Where the startup has been recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), but the case is selected for “limited scrutiny” only to determine applicability of section 56(2)(viib), the contentions of startups are to be summarily accepted without any inquiry or verification by the assessing officer (AO).
  2. Where the startup has been recognized by the DPIIT, but the case is selected under “limited scrutiny” with multiple issues for determination or “complete scrutiny” including determination of applicability of section 56(2)(viib), applicability of section 56(2)(viib) will not be pursued during assessment, and inquiry or verification on other issues shall be carried out by the AO as per due procedure under the ITA, but after obtaining approval of the supervisory officer.
  3. Where the startup has not been recognized by the DPIIT, and the case is selected for scrutiny inter alia on grounds of applicability of section 56(2)(viib), inquiry or verification on all issues shall be carried out by the AO as per due procedure under the ITA, but after obtaining approval of the supervisory officer.

The CBDT has further clarified that the exemption from section 56(2)(viib), which only applied to startups for which assessment orders were passed after the date the of DPIIT Notification (i.e., after 19 February 2019), would also extend to for cases where an assessment order was passed before the DPIIT Notification.

In a press conference on 23 August 2019, the finance minister also declared that startups recognized by the DPIIT will be exempt from application of the angel tax altogether.

The business law digest is compiled by Nishith Desai Associates, a research-based international law firm with offices in Mumbai, New Delhi, Bengaluru, Singapore, Silicon Valley, Munich and New York. The firm specializes in strategic legal, regulatory and tax advice coupled with industry expertise in an integrated manner.