Question: We are a recently established Private company intending to raise capital by way of issuing shares to both residents as well as non-residents. In this respect, kindly guide us on the tax implications of the Angel Tax and the recent amendments made pertaining to the same.
Dr Suresh Surana, Founder, RSM India, answers:
Section 56(2)(viib) of the Income Tax Act, 1961 (hereinafter referred to as ‘the IT Act’) provides that where a closely held company issues shares to an investor at a value which is higher than the face value of such shares, then the excess of such issue price over the Fair Market Value would be subjected to tax as “Income from other Sources” in the hands of the company issuing such shares. Taxing such excess consideration is generally known as “Angel Tax”. However, the said provision would not be applicable in case of issuance of shares by eligible startups as well as in certain cases where the issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund or a specified fund.
For the aforesaid purpose, FMV of the equity shares is determined in accordance with the methods prescribed under Rule 11UA of the IT Rules i.e. either through the book value method (‘NAV’) or the discounted cash flow (‘DCF’) method, at the option of the company. Recently, CBDT has made the following changes to Rule 11UA:
In addition to the 2 methods for valuation of shares, namely, DCF and NAV method, available to residents under Rule 11UA, 5 more valuation methods have been made available for non-resident investors:
Comparable Company Multiple Method
Probability Weighted Expected Return Method
Option Pricing Method
Milestone Analysis Method
Replacement Cost Method.
A safe harbor of 10% variation in value has been provided in accordance with which if the issue price of the shares exceeds the value determined per Rule 11UA by no more than 10%, then, the issue price will be considered as the FMV.
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If a closely held company receives consideration for the issuance of shares from any notified entity, the price of the shares related to that consideration can be considered as the FMV of such shares for both resident and non-resident investors. However, such consideration would be to the extent the consideration from such FMV does not exceed the aggregate consideration that is received from the notified entity and the consideration has been received by the closely held company from the notified entity within a period of 90 days before or after the date of issue of shares which are the subject matter of valuation.
On similar lines, such price matching for resident and non-resident investors would be available with reference to investment by Venture Capital Funds or Specified Funds.
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