New Angel Tax Rules For Indian Startups and Investors

Context:

• The Income Tax Department has notified new angel tax rules that comprise a mechanism to evaluate the shares issued by unlisted startups to investors.

Previous Angel Tax Rules

• While previously the angel tax applied only to local investors, the Budget for 2023-24 fiscal (April 2023 to March 2024) widened its ambit to include foreign investments.

What are the New Angel Tax Rules?

• As per the changes in Rule 11UA of I-T rules, the Central Board of Direct Taxes (CBDT) provides that the valuation of compulsorily convertible preference shares (CCPS) and equity shares issued by unlisted startups can be based on the fair market value.
• The amended rules also retain the five new valuation methods proposed in the draft rules for consideration received from the non-residents:
  • Comparable Company Multiple Method,
  • Probability Weighted Expected Return Method
  • Option Pricing Method
  • Milestone Analysis Method
  • Replacement Cost Method.
• Significance: The amended rule brings in more clarity for both investor and investee basis that an appropriate valuation method can be adopted, thereby, reducing the chances of any future litigation.

What is an Angel tax?

Angel tax is the tax levied on the capital raised via the issue of shares by unlisted companies if the share price of issued shares is seen in excess of the fair market value of the company.

• For example: If a startup receives 50 crores of investment by issuing 1 lakh shares at Rs.5000 each to an Indian investor and the fair market value is Rs.2000 per share i.e. Rs.20 crore only, then the startup will have to pay angel tax on the amount in excess of the fair market value i.e Rs. 30 crores.
• When an angel investor funds the new business ventures, the startup is obliged to pay a part of their investment as tax to the government under Section 56 (2) (vii) (b) of the  Income Tax Act of 1961.
• Earlier, it was imposed only on investments made by a resident investor. However, the Finance Act 2023 proposed to extend angel tax even to non-resident investors from April 1, 2024.
• It is levied at a rate of 30.9% on net investments in excess of the fair market value.

Rationale Behind Angel Tax

• The government introduced the Angel Tax to curb money laundering and make it easier for businesses to comply with the tax norms.

Criticism

Startups tend to lose a significant amount of money in the form of taxes as angel tax requires them to share a significant part of the investment.

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