What is Angel Tax?
Angel tax was introduced in 2012. The main focus of angel tax is on reducing money laundering through the purchase of shares at a high premium.
Angel tax of about 30% plus applicable cess is charged on the amount that exceeds the fair market value (FMV) of shares issued by unlisted companies, which is treated as income from other sources.
Angel tax is charged on investments made by external investors in start-ups or companies. To explain, the entire fund is not taxed, only the amount that is considered above “fair value” valuations of the start-up, classified as ‘Income from Other Sources’ in the Income Tax Act of India.
What does the Law say about Angel Taxation in India?
Section 56(2)(viib) of the Income Tax Act 1961:-
Where a closely held company issues equity shares which is more than its fair market value (Consideration per share less Fair Value per Share) then the amount received in excess of fair market value of shares will be charged to tax in the hand of company as Income from Other Sources and thus such company has to pay tax on such excess amount @ 30% plus cess as applicable.
This section is the basic of Angel Taxation. We can just say that, “When income tax payable on funds raised by unlisted company by issuing of shares on a price greater than the fair market value (FMV) of the shares, then income tax paid on such excess receipts is known as Angel Tax and similarly the persons investing in these shares are known as Angel Funders.
Bare Section of the Income Tax Act, 1961.
As per Section 56(2)(viib) of the The Income Tax Act 1961, where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any individual person being a resident, any consideration for issue of shares which exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares.
Provided that Section 56(2) (viib) shall not apply where the consideration for issue of shares is received —
- By a venture capital enterprise from a venture capital company or a venture capital fund; or
- By a company from a class or classes of persons which may be notified by the Central Government in this behalf.
What is Venture Capital Company?
Venture Capital Company is the one which has received the certificate of registration (as applicable) from Securities and Exchange Board of India and complies with prescribed conditions as prescribed in explanation to Section 10(23FB).
What is Fair Market Value (FMV)?
The fair market value (FMV) of the shares shall be the value—
- as may be determined in accordance with such method as may be prescribed (Rule 11U and 11UA) or
- as may be verified by the company to the satisfaction of the AO (Assessing Officer), based on the value, on the date of issue of shares, of its assets, including intangible assets like goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of parallel nature,
Whichever is higher;
Rule 11U of the income tax rules provide for the meaning of expressions used in the determination of fair market value while following methods prescribed under Rule 11UA of the income tax rules.
Rule 11UA, on the other hand, provides for methods of determining the fair market value of a property, other than immovable property, including valuation of:-
- Archaeological collections,
- Drawings, paintings, sculptures or any work of art
- Shares and securities (both quoted and unquoted
Reliefs to Angel Firms
Notification no. G.S.R. 364(E) issued on 11 April 2018. In this notification, the following matters were considered:-
Definition of Start-up:- An entity up to first 7 years (10 years in case of biotechnology sector) of incorporation (including Pvt Company or Partnership firm or LLP) + Turnover for any year since incorporation is not exceeding Rs. 25 crores + Entity in business as may be prescribed.
Exemption from Section 56(2)(viib):-
- The total amount of paid-up share capital and security premium of the start-up after the proposed issue of shares does not exceed Rs. 10 crores
- The investor, who proposed to subscribe to the issue of shares of the start-up has, —
- Average returned income of Rs. 25 Lakhs or more for the preceding 3 financial years;
- The net worth of Rs. 2 crores or more as on the last date of the preceding financial year
- Start-up has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.
Resource: ICSI CS Executive module 2019