Angel Tax—- IFs and BUTs

Now a days we are hearing a lot of noise about Angel Tax so today we will discuss in details what the term Angel Tax Stands for, what are its repercussions on taxation of various start-ups, why is everybody disturbed about it. So lets starts this roller coaster ride of Angel Tax with all the terms associated with it: –

ANGEL TAX: –

The most prominent and easiest way of evasion of tax on black money was issuance of shares in privately and closely held companies at a huge premium (what we have always heard in the cases of black money converted by politician and most prominent in recent days was Lalu Yadav Farm House Case of Bijwasan). In the Year 2012 the then Finance Minister Sh. Pranab Mukherjee introduced new sub-section (viib) in section 56 of the IT Act, 1961 and the same is re-produced here for discussion, (this was inserted vide Finance Act 2013 and made applicable from 01.04.2013 i.e. for AY 2013-14)

(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that 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 this clause shall not apply where the consideration for issue of shares is received—

 (i)  by a venture capital undertaking from a venture capital company or a venture capital fund; or

(ii)  by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

Explanation.—For the purposes of this clause,—

(a)  the fair market value of the shares shall be the value—

(i)  as may be determined in accordance with such method as may be prescribed⁹; or

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,

whichever is higher;

(b)  “venture capital company”, “venture capital fund” and “venture capital undertaking” shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause (23FB) of section 10;

In a layman’s language if a closely and privately held company issue new shares to a domestic investor at premium and that premium is more than the fair market value determined as per Rule 11UA of the Income Tax Rules, 1962 then this extra premium is treated as income under the head other sources resulting in extra taxation for the company and this extra tax is called in common parlance as ANGEL TAX because it largely impacted angel investments in startups.

The basic reason for insertion of this section was to arrest laundering of funds. The intention behind insertion of new section was good but its implementation has resulted in a lot of litigation and the main point of litigation is valuation mechanism defined in sub-rule 1(c) Rule 11UA of the Income Tax Rules 1962 which revolves largely around the Net Assets Value Method but startups are generally valued by the investor on commercial negotiation based on future projections of income and basically governed by Discounted Cash Flow Method. This is the main point of contention between the startups and government.

A lot has been discussed about THIS ANGEL TAX in last two years at various forums and after deliberate discussions government has modified the original notification dated 11th April 2018 and on 16th January 2019 has simplified some of the terms for claiming exemption from Angel Tax. Since original notification has also been modified which means that terms has been modified respectively.

The exemption has now been provided to all DIPP registered Startups if the paid up capital and share premium post issuance of new share capital does not exceed Rs. 10.00 Crores,

There are many other points under litigation which needs to be sorted out at the earliest to avoid all future dispute and main point as discussed here-in-above is DIFFERENCE IN VALUATION MECHANISM ADOPTED BY THE DEPARTMENT AND FOLLOWED BY THE STARTUPS.