Taxation Of Startups – Angel Tax: Complete Guide
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This is a guide to the levy of “angel tax” on start-ups. It summarizes the legislative amendments made to the Income-tax Act 1961 and also the various circulars and instructions issued by the CBDT.
What is “angel tax”?
Section 56(2)(viib) (Section) of the Indian Tax Laws (ITL) (popularly known as the “angel tax” provisions) is an anti-abuse provision which applies when a CHC issues shares (including preference shares) to a resident at a premium and receives consideration which is in excess of the FMV of the shares. The excess amount so received is deemed as income from other sources in the hands of the CHC in the year of issue of the shares.
• Rule 11UA of the Income Tax Rules (Valuation Rules) prescribes the valuation methodology for determining the FMV of various types of assets (including unquoted equity shares), not only for the purposes of the angel tax provision, but also for other anti-abuse provisions involving transfer of assets without consideration or at a value less than the FMV.
• The FMV of unquoted equity shares for the purpose of the angel tax provision read with Rule 11UA is the higher of the following:
Net asset value as reflected in the audited balance sheet of the CHC (break-up value method)
OR
The DCF value as determined by a Category-I MB or Accountant
OR
The value that the company is able to substantiate to the satisfaction of the Tax Authority, basis the holding of various intellectual property rights (IPRs) like goodwill, know-how, patents, copyrights etc.
• In case of unquoted shares and securities other than equity shares in a company not listed in any recognized stock exchange, as per Rule 11UA, the FMV is the estimated open market value as may be determined by a Category I MB or Accountant. This rule applies to both angel tax and other anti-abuse provisions.
• Prior to the Valuation Notification, the term “Accountant” was defined as under:
• For angel taxation: In case of valuation of unquoted equity shares, an Accountant is a Fellow CA who is not appointed as a tax auditor under the ITL or as a statutory auditor under the Companies Act, 2013.
• For other anti-abuse provisions: Any CA in practice who can act as an Authorized Representative for the taxpayer and fulfils the independence criteria as prescribed under the ITL.
• Changes brought about by the Valuation Notification are as follows:
• The Valuation Notification has withdrawn the option given to the taxpayer to obtain a valuation report from a CA for determining the FMV of unquoted equity shares based on the DCF method for the purpose of the angel tax provision. As a
consequential amendment, it has also omitted the definition of “accountant”.
• Thus, where the taxpayer wishes to rely on the DCF method, it can now obtain a DCF valuation report only from a Category 1 MB. A valuation report from a practising CA will no longer be a valid compliance for the angel tax provision.
• However, it may be noted that the above change applies only to the valuation of unquoted equity shares required for the angel tax provision by adopting the DCF method option. For shares other than unquoted equity shares (like preference
shares), the taxpayer continues to have the option to obtain a valuation report from either a Category I MB or a CA. The changes in Rule 11UA are depicted in the table at Annexure.
• The aforesaid amendment comes into force from the date of publication in the official gazette i.e., 24 May 2018.
• Exemption from the angel tax provision for eligible
DOWNLOAD: Download Guide To Angel Tax On Startups – CBDT Circulars, Notifications, Press Note, Instructions
“start-ups”
• The angel tax provision does not apply to shares issued by a venture capital undertaking to a venture capital fund or a venture capital company[“Venture capital undertaking”, “venture capital fund” and “venture capital company” shall have meaning as assigned under Explanation(c) to Section 10(23FB) of the ITL].
• In addition, the provision does not apply when shares are issued to a class or classes of persons as notified by the CG. Pursuant to exercise of this power, the CG issued the following notifications with corresponding reference to the DIPP notifications.
• The additional conditions imposed by the 2018 DIPP Notification for start-up companies are:
• A cap of INR100m on the aggregate of paid-up share capital and share premium post issue of shares.
• Requirement to furnish a valuation report obtained from a Category I MB specifying the FMV of the shares, in accordance with Rule 11UA.
• As per the 2018 DIPP Notification, the conditions required to be fulfilled by the investor are, either:
• Average returned income of INR2.5m or more for the preceding three financial years.
OR
• Net worth of INR20m or more on the last date of the preceding financial year.
• The Start-up Notification aligns with the 2018 DIPP Notification and provides that where shares are issued at premium for a consideration in excess of the FMV, the angel tax provision shall not apply on such consideration received from an investor by a start-up company, in accordance with the approval granted by the IMB under the 2018 DIPP Notification.
• This change comes into force retrospectively from 11 April 2018, being the date on which the 2018 DIPP Notification was issued/published in the official gazette.
Key amendments of Finance (No. 2) Bill, 2019 relating to Angel tax on startups
Withdrawal of exemption and automatic levy of penalty where start-ups breach condition for angel tax exemption
► FB 2019 proposed to introduce claw back provision for “angel tax” exemption availed of by start-up companies in the event of breach of any of the notified conditions. “Angel tax” refers to taxation of excess premium received by a closely-held company from a resident investor (i.e., consideration received in excess of fair market value of shares). But, the claw back was proposed for the whole premium (consideration received in excess of face value of shares), instead of only excess premium.
► At the enactment stage, the claw back is restricted to only excess premium over fair market value, but with a more onerous consequence that such claw back shall be deemed to be misreported income attracting penalty @ 200% of the excess premium.
Angel tax exemption extended to issue of shares to all sub-categories of Category-I AIFs
► FB 2019 proposed to extend exemption from angel tax currently available for investment by a Venture Capital Company or a Venture Capital Fund (being a sub-category of Category-I AIF) in a Venture Capital Undertaking to investment by Category-II AIFs also. This left out other sub-categories of Category-I AIFs like infrastructure fund, social venture fund, SME fund etc.
► At the enactment stage, the exemption is extended to all sub-categories of Category-I AIFs. Thus, investment by any entity in Category-I or Category-II AIF in a Venture Capital Undertaking (including a recognized start-up) will now be exempt from angel tax.
CBDT notifies exemption for start-ups from ups from “angel tax” as per relaxations notified by DPIIT
Notification No. 13 of 2019 dated 5 March 2019 was issued by the Central Board of Direct Taxes (CBDT) in relation to exemption to start-ups from taxation of excess share premium received by such start-up companies from a resident investor under an anti-abuse provision of the Indian Tax Laws (ITL) popularly known as the “angel tax” provision.
On 19 February 2019, the Department for Promotion of Industries and Internal Trade (DPIIT) issued a Notification (2019 DPIIT Notification) which substantially relaxed the conditions and procedure for exemption from “angel tax” for start-up companies by adopting a “green channel” process in place of the earlier approval-based process.
In order to claim exemption, the “start-up company” which fulfils the modified conditions[4] has to merely file a self-declaration stating that the eligible start-up has not invested in non-qualifying assets[5] which shall be transmitted by the DPIIT to the CBDT.
In the light of new exemption regime prescribed by the 2019 DPIIT Notification, the present CBDT Notification, as a consequential step, supersedes the earlier CBDT Notification[6] and grants exemption to start-ups from “angel tax” provision if the start-up company complies with the conditions specified in the 2019 DPIIT Notification.
The present CBDT Notification comes into force retrospectively from 19 February 2019, being the date of the 2019 DPIIT Notification.
In relation to past issue of shares, in line with the 2019 DPIIT Notification, the relaxation will not apply to prior years where assessment orders in relation to angel tax have already been passed by the Tax Authority. As per news reports, the CBDT has instructed the Tax Authority not to take coercive action and ensure speedy disposal of such appeals on priority.
But where no such demands are raised or notices are received but assessment orders are yet to be passed, taxpayers can expect relief from angel tax provision by complying with the 2019 DPIIT Notification. If conditions of the 2019 DPIIT Notification are not fulfilled, taxpayers will need to defend their case on merits by justifying the share valuation.
It may also be noted that the present CBDT Notification does not address invocation of broader provisions to treat share investments by non-resident investors as unexplained cash credits.
CBDT lays down administrative mechanism for pending assessments of start-up companies
The Central Board of Direct Taxes (CBDT) issued Circular No. 16/2019 dated 7 August 2019 in relation to the manner of conducting assessment proceedings (including pending assessments as of date), involving angel tax and other issues, in case of start-up companies.
Angel tax, under the Indian Tax Laws (ITL), refers to a tax on premium received by a closely-held company on issue of shares in excess of the fair market value (FMV) of the shares.
Such FMV is determined basis normative valuation rules or the valuation report by a merchant banker or any other basis as substantiated to the satisfaction of the Tax Authority.
With a view to promote the start-up industry, the CBDT issued a notification[3] stating that “start-up” companies which satisfy the conditions prescribed under the notification[4] issued by the Department for Promotion of Industries and Internal Trade (DPIIT) (2019 DPIIT Notification) will be exempt from the levy of angel tax. The 2019 DPIIT Notification, however, did not explicitly provide any relief where the assessment proceedings are pending with the Tax Authority.
► In wake of representations from the start-up industry, through the Budget Speech on 5 July 2019, the Finance Minister had announced that the CBDT shall frame a special administrative mechanism for disposing pending assessments of start-ups and for redressal of grievances. The Finance Minister also assured that, for start-up companies, the Tax Authority shall not conduct inquiry or verification without the approval of the supervisory officer.
► Pursuant thereto and by exercising powers granted to the CBDT under the ITL for proper administration, the CBDT Circular was issued on 7 August 2019 for granting relaxation to start-up companies in relation to the manner of conduct of pending assessments for angel tax and other issues.
► The CBDT Circular was issued in light of various instances where notices for conducting assessment or reassessment have been issued by the Tax Authority before or after the issue of the 2019 DPIIT Notification and where such cases are, presently, pending for disposal.
The relaxation provided by the CBDT is as follows:
► Procedure for completion of pending assessment for recognized start-ups: In case of recognized start-up companies satisfying the conditions for availing angel tax exemption under the 2019 DPIIT Notification, the procedure shall be as follows:
o In case of “limited scrutiny” where the sole issue of applicability of angel tax is being examined, the Tax Authority shall not conduct any verification. The Tax Authority is directed to summarily accept the contentions of recognized start-up companies.
o In case of “limited scrutiny with multiple issues” or “complete scrutiny” where assessment is conducted in case of other issues along with examination of levy of angel tax, the issue of angel tax shall not be pursued by the Tax Authority.
Furthermore, the Tax Authority shall conduct inquiry or verification for other issues only after obtaining the approval of the supervisory officer. Furthermore, in relation to other issues, assessment proceedings shall be conducted as per the procedure laid down under the ITL.
► Procedure for start-up companies not having DPIIT approval: In such cases where the assessment is being conducted for angel tax or other issues, the Tax Authority shall conduct inquiry or verification only after obtaining the approval of the supervisory officer.
Adhering to the promise of the Finance Minister, the CBDT has taken a proactive measure to clear the air on the outcome of assessment proceedings of start-up companies. While this is a welcome move, the said directions are not applicable in relation to the issues of start-up companies which are pending at the appellate level and assessments have already been conducted by the Tax Authority in past years.
CBDT extends Angel tax exemption to start-up companies for completed assessments of past years
The Central Board of Direct Taxes issued Instruction No. F.No.173/354/2019-ITA-1 dated 9 August 2019 (CBDT Instruction) to extend exemption from Angel tax to start-up companies where addition of income in relation to Angel tax is made in assessment orders passed before 19 February 2019.
“Start-up” companies which satisfy the conditions prescribed under the notification[4] issued by the Department for Promotion of Industries and Internal Trade (DPIIT) [5] (2019 DPIIT Notification) are exempt from the levy of Angel tax[6]. The 2019 DPIIT Notification extended the condition-based exemption to past and proposed issue of shares undertaken by start-up companies. However, it did not provide any relaxation where an addition has been made in relation to Angel tax in an assessment order before issue of 2019 DPIIT Notification i.e., prior to 19 February 2019.
In order to mitigate hardship caused to the start-up companies, the CBDT has, on realization of the lacuna, issued a clarification on 9 August 2019 to relieve recognized start-ups where addition is made for Angel tax income in assessment order passed before 19 February 2019. To claim such an exemption, the start-up company is required to submit self-declaration as required in the 2019 DPIIT Notification confirming that all the conditions laid down in the said Notification are fulfilled.
The CBDT clarification follows the CBDT Circular[7] which lays down administrative mechanism for conduct of assessment proceedings (including pending assessments). The present CBDT instruction is a welcome move which directs the Tax Authority to grant Angel tax exemption in case of past years where assessment orders were passed before the date of 2019 DPIIT Notification. The Government of India has been proactive in resolving the concerns faced by the start-ups.
Accordingly, start-up companies which are recognized and have filed requisite declaration to the CBDT may apply for rectification of assessment order passed by the Tax Authority within the time limit prescribed under the ITL. In case of on-going assessment proceedings at appellate level, the present CBDT clarification may help the start-up companies to defend their cases before the relevant authorities.
CBDT forms dedicated cell for start-ups to redress tax grievances
The Central Board of Direct Taxes (CBDT) issued Order dated 30 August 2019 for setting-up of a dedicated cell for start-ups (“Start-up Cell”) to redress the grievances and address the various issues under Indian Tax Laws (ITL), including angel tax. The CBDT Order is issued in light of the announcement made by the Finance Minister in Budget Speech as also at the press meeting held on 23 August 2019.
The Start-up Cell comprises the officials from different hierarchy at CBDT and can be contacted over telephone number (011-23095479/23093070 (F)) and email id (startupcell.cbdt@gov.in).
The CBDT Order is issued to implement the announcement made by the Finance Minister in Budget Speech on 5 July 2019 as also at the press meeting held on 23 August 2019 and is the latest in a series of proactive steps undertaken by CBDT to provide impetus to Start-up industry and clarify the ambiguities under the ITL.
The Start-up Cell comprises the following officials from different hierarchy at CBDT:
Official Designation in Start-up Cell
Member (Income Tax and Computerisation)
Chairman
Joint Secretary -Tax Policy and Legislation-II
Member
Commissioner of Income Tax (ITA)
Member
Director (ITA-I)
Member Secretary
Under Secretary (ITA-I)
Member
The Start-up Cell can be contacted over telephone number (011-23095479/23093070 (F)) and email id (startupcell.cbdt@gov.in) provided in the Order. The official address of the Start-up Cell is located at Room No. 245A, North Block, New Delhi – 110001.
This recent initiative by the CBDT is aimed to ease the compliance issues for start-ups. The CBDT Order is the latest in a series of proactive steps undertaken by CBDT to provide impetus to Start-up industry and clarify the ambiguities under the ITL. Earlier, on 5 March 2019, the CBDT issued a Notification to provide exemption from angel tax to start-ups satisfying the prescribed conditions.
Subsequently, in July 2019, the Finance (No.2) Act, 2019 introduced several measures to ease the tax burden in the hands of start-ups and their promoters[4]. Thereafter, as promised by the Finance Minister in Budget Speech on 5 July 2019, the CBDT laid down a specific administrative mechanism for pending assessments of start-ups involving angel tax and other issues.
The CBDT also extended the benefit of angel tax exemption to start-ups where additions were made in assessment orders passed before 19 February 2019. Also, in a press meeting on 23 August 2019, the Finance Minister announced a blanket relaxation from angel tax to start-ups registered with Department for Promotion of Industry and Internal Trade. These measures are expected to address the tax issues of start-ups and improve ease of doing business for such entities.