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Angel tax is a term commonly used to describe the tax imposed under Section 56(2)(viib) of the Income Tax Act, 1961 in India. This provision applies when an unlisted company, typically a startup or closely held firm, issues shares to investors at a price exceeding the fair market value (FMV) of those shares. The excess amount—considered as income from other sources—is then subject to taxation. Originally introduced to curb money laundering through inflated valuations, the provision has also affected genuine early-stage investments, prompting ongoing debates and regulatory revisions to balance tax enforcement with startup ecosystem growth.
Angel tax was first introduced in 2012 as a regulatory measure to curb money laundering and discourage the use of shell companies for routing unaccounted capital. The intent was to prevent companies from inflating share prices and showing fictitious capital inflows, which could be used to legitimize black money. While the provision aimed at increasing transparency and accountability, it inadvertently created friction within the startup ecosystem, where high valuations based on future potential—not current assets—are common. As a result, the tax has drawn criticism for affecting investor confidence and hindering early-stage funding.
Unlisted companies (primarily startups) receiving investments from Indian resident investors.
If the share issue price exceeds the FMV, the excess amount is taxable.
Startups recognised by DPIIT and meeting specific conditions (such as turnover limits and investment ceiling) are exempt.
Non-resident investors were earlier exempt but were brought under the net again with amendments in 2023, which have caused concern.
Angel tax is levied on startups that receive funding above the fair market value of their shares from investors. In India, such excess funding is treated as income and taxed under Section 56(2)(viib) of the Income Tax Act.
The angel tax rate is typically 30% (plus applicable surcharge and cess) on the amount exceeding the fair market value. However, DPIIT-recognized startups that meet certain conditions are exempt from angel tax to encourage entrepreneurship and ease of funding.
The possibility of angel tax implications can discourage private investors from funding early-stage ventures, as their investments may attract additional tax scrutiny despite being genuine.
Startups often operate with limited capital. Unexpected tax demands under angel tax provisions can put pressure on their cash flows, diverting funds from essential activities like product development and market expansion.
Determining the fair market value (FMV) is not always straightforward. Startups generally use forward-looking valuation methods, whereas tax authorities may apply conservative approaches like Net Asset Value (NAV) or Discounted Cash Flow (DCF), leading to discrepancies.
Complying with angel tax requirements involves maintaining comprehensive valuation reports and detailed documentation to justify share pricing. This can increase the compliance load, especially for resource-constrained startups.
In 2023, the scope of the angel tax was extended to cover investments from non-resident investors, broadening its applicability beyond domestic funding sources. This move aimed to align tax enforcement with evolving capital flows but also raised fresh concerns among global investors and startups.
To mitigate the impact on genuine ventures, the Department for Promotion of Industry and Internal Trade (DPIIT) and the Central Board of Direct Taxes (CBDT) introduced updated procedures for registered startups to claim exemptions, offering relief through formal recognition and compliance.
Additionally, tax authorities issued clearer guidelines on acceptable valuation methodologies, such as the Discounted Cash Flow (DCF) and Net Asset Value (NAV) methods. While these efforts aimed to bring consistency, interpretation challenges still persist, particularly in aligning investor expectations with regulatory benchmarks.
Funding Deterrent
Startups may struggle to attract investors due to the tax liability on excess funding, discouraging early-stage investments.
Valuation Disputes
Tax authorities may disagree with startup valuations, leading to scrutiny and disputes, even when valuations are based on business potential.
Cash Flow Issues
The tax burden can strain a startup’s limited cash reserves, impacting operations and growth plans.
Compliance Burden
Startups face increased paperwork and scrutiny, diverting focus from innovation to regulatory compliance.
Angel tax has long been a contentious issue in India’s startup ecosystem. While intended to curb abuse of capital flows, its broad application has sometimes discouraged genuine investments. Regulatory clarifications and exemptions help, but concerns around compliance and fair valuation remain. For startups, being DPIIT-registered and ensuring transparent valuation methods are key to avoiding tax hurdles.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Angel tax was introduced as a safeguard against money laundering by preventing unlisted companies from raising funds at unjustified valuations. It targets the gap between the issued share price and its fair market value.
Yes. Effective from April 2023, the angel tax provisions were extended to cover investments from non-resident investors, unless the startup qualifies for specific exemptions.
Yes, startups can seek exemption by registering with the Department for Promotion of Industry and Internal Trade (DPIIT) and fulfilling conditions such as turnover limits, incorporation age, and investment caps.
The Fair Market Value (FMV) of shares is typically assessed using either the Discounted Cash Flow (DCF) method or the Net Asset Value (NAV) method. This valuation must be validated and certified by a SEBI-registered merchant banker.
No, the tax liability falls on the startup receiving the funds. However, it may indirectly affect investors by increasing post-investment scrutiny and reducing the attractiveness of investing in early-stage companies.
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