Angel tax exemption: Is there a real benefit?

The government introduced the Startup India Action Plan on 16 January 2016, in an effort to boost the startup ecosystem and promote ease of doing business. As a part of the action plan, various steps are being taken to foster seed investment in early-stage businesses.

Startups rely heavily on funding. Typically, investment in a startup is made by issuing shares at a premium, which is calculated based on the valuation of the company. As most startups are at a conceptualization stage, valuation usually takes into consideration forward-looking projections, which renders the process subjective. Therefore, arriving at an appropriate valuation and determining the fair market value (FMV) of the shares is more of an art than a science.

However, issuance of shares to a resident of India for a premium in excess of the FMV is taxed exorbitantly. This tax, known as “angel tax”, is levied under the head “income from other sources”, under section 56(2)(viib) of the Income Tax Act, 1961 (ITA). However, the tax is not imposed if the investment is from a venture capital company or a venture capital fund. Angel tax has been a long-standing pain-point for early-stage businesses.

Nivedita Nivargi is a partner and Bhadra Menon is an associate in the Bengaluru office of Samvad Partners.