The Centre on Tuesday notified the final rules outlining valuation methods for non-resident and resident investors under the new angel tax mechanism based on changes made in the Finance Act 2023.
Angel tax (income tax at the rate of 30.6 per cent) will be levied when an unlisted company issue shares to an investor at a price higher than its fair market value. The new rules will be effective from September 25.
As per the notification, all the five valuation methodology from the draft rules have been retained in the final regulation. A mechanism for arriving at the fair market value of Compulsorily Convertible Preference Shares (CCPS) for investment from residents as well as non-resident residents has also been adopted.
Earlier, only investments made by a resident investor used to attract angel tax, however, it was extended to non-resident investors in the current budget. However, Budget 2023–24 introduced provisions to extend the angel tax to non-resident investors as of April 1, 2024.
The Finance Act, 2023, has amended Section 56(2) (viib) of the I-T Act, thereby bringing overseas investment in unlisted held companies under the tax net.
In layman's terms, 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.
The CBDT had in May come out with draft rules on valuation of funding in unlisted and unrecognised startups for levying income tax, commonly termed as 'Angel Tax' and had invited public comments on it.
The amended rules are aimed at bridging the gap between the rules outlined in FEMA and the Income Tax.
Rules explained
As per the Income Tax Act, share premium received by entities without substantial public interest are taxable as 'income from other sources'.
Start-ups have been claiming that this rule affects their ability to raise capital as most of these entities negotiate diluting their stake in the company based on future valuation of the company.
By giving flexibility in the valuation methods, the Centre seeks to ensure that future prospects of the company are also taken into consideration in the valuation for tax purposes.
As per the latest 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) can also be based on the fair market value of unquoted equity shares.
The rules specify that the fair value of the shares will be as determined by the methods provided.
Anything above, after accounting for a 10 per cent margin, will be deemed as "taxable premium".
The amended rules also retain the five new valuation methods proposed in the draft rules for consideration received from the non-residents viz., (i) Comparable Company Multiple Method, (ii) Probability Weighted Expected Return Method, (iii) Option Pricing Method, (iv) Milestone Analysis Method, and (v) Replacement Cost Method.
Nangia & Co LLP Partner Amit Agarwal told news agency PTI that the amendments to Rule 11UA of the Indian Income Tax Act bring positive changes by offering taxpayers flexibility through multiple valuation methods, simplifying the valuation date consideration, incentivising venture capital investments, facilitating investments from notified entities, providing clarity on CCPS and encouraging foreign investments.
"The inclusion of a tolerance threshold for minor valuation discrepancies further enhances efficiency and fairness in tax assessments, ultimately benefiting both taxpayers and the government."
He added: "These changes offer taxpayers a broader range of valuation methods to choose from, including internationally recognized approaches, thereby attracting foreign investments and fostering clarity. Moreover, the notified final rule introduces an additional sub-clause specifically addressing CCPS."
AKM Global Tax Partner Amit Maheshwari said the new angel tax rules have very well taken care of an important aspect of CCPS valuation mechanism which was not the case earlier since most of the investments in India by VC funds is through the CCPS route only.
"The extension of 10 per cent safe harbour to CCPS investments as it was earlier meant for equity shares will give a necessary margin of safety for taking care of foreign exchange fluctuations and is a welcome move," Maheshwari added.
Earlier, experts told Business Today that the angel tax changes were much-needed, considering the somber mood within the ecosystem owing to the funding winter. According to a report by Tracxn Technologies, in the first quarter of calendar year 2023, Indian startups raised $2.8 billion which is a 75 per cent decline from the Q1 of 2022. The ecosystem stakeholders believe that the inflow of foreign capital, especially, in the current times is of paramount importance.
Sudhanva Sundararaman, Senior Director at Deshpande Startups (which is an incubation center) says that start-ups need “additional capital options beyond domestic-based funds” to brave the storm of cash crunch.
“The good part is that this development will attract a wider range of institutional investors to facilitate ongoing investments in the country,” Sundararaman told BT.
Also read: Angel tax changes will help start-ups combat funding winter, bring foreign capital: Experts
Also read: CBDT notifies 21 nations from where investment in start-ups will be exempt from angel tax