CBDT proposes relief from angel tax pursuant to Budget 2023 amendment expanding scope to non-resident investment

Section 56(2)(viib) of the Income Tax Act (popularly known as the “angel tax” provision) is an anti-abuse provision which applies when a Closely Held Company (CHC) issues shares (including preference shares) at a premium and receives consideration which is in excess of the fair market value (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. However, investments by venture capital funds (VCFs) are exempted from angel tax.

Rule 11UA of the Income Tax 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 existing Rule 11UA, is the higher of the following:  

• Net asset value as reflected in the audited balance sheet of the CHC (NAV method); or
  
  
• The Discounted Cash Flow (DCF) value as determined by a Category-I merchant banker (DCF method); 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.

Prior to amendment by the Finance Act 2023 (FA 2023), the angel tax applied only to shares issued to a resident. FA 2023 amended the angel-tax provisions, with effect from tax year 2023-24, to extend it to issue of shares by a CHC to non-resident (NR) investors. FA 2023 also extended the exemption from angel tax to investments in CHC by VCFs set up in IFSC (specified funds).

Stakeholders made various representations to the Government on challenges arising from expansion of angel tax to investments by NR investors.

This tax alert summarizes the press release issued by CBDT on 19 May 2023 announcing a slew of relief on aspects of angel tax.