Centre softens angel tax rules
Context
On investments made by non-resident investors into start-ups at a premium over their fair market value, the government has loosened some of the provisions of the angel tax that was established in this year’s Budget. It incorporated five distinct share valuation techniques and provided a 10% tolerance for departures from the generally accepted share valuations.
What are the Angel Tax Rules?
- Angel Tax, formally known as Section 56(2)(vii B) of the Income Tax Act of 1961 is a tax on the excess capital raised by unlisted companies from investors, particularly angel investors when the investment amount exceeds the fair market value (FMV) of the shares issued.
What is the definition of a start-up according to the Angel tax rules?
To be eligible for certain exemptions from Angel Tax, a startup must be defined as per the Department for Promotion of Industry and Internal Trade (DPIIT) guidelines. The definition typically includes companies that are less than ten years old, have an annual turnover not exceeding Rs 100 crore, and are engaged in innovation, development, deployment, or commercialization of new products, processes, or services driven by technology or intellectual property.
What are the criteria for getting an Angel Tax exemption?
- DPIIT Registration: Startups that want to be exempt from the angel tax must register with the DPIIT.
- Merchant Banker Valuation: A merchant banker shall use the prescribed methodology to estimate the fair market value of the startup’s shares.
- Investor Criteria: Individual investors must meet minimum net worth and income criteria.
- Valuation of Shares: The fair market value (FMV) of the startup’s shares is essential. If the investment amount received is more than the FMV, the extra amount may be considered income and be subject to Angel Tax.
- Exemption for Investments by Certain Entities: Investments by venture capital funds, listed companies, and non-resident investors are usually exempt from Angel Tax. These exemptions are meant to encourage investment in startups.
What is the latest introduction to the Angel Tax Return?
Five Valuation Methods
- Net Asset Value (NAV) method: This method calculates the value of a company by adding up the value of all its assets and subtracting the value of all its liabilities.
- Discounted Free Cash Flow (DCF) method: This method calculates the value of a company by discounting the future cash flows that the company is expected to generate.
- Comparable Companies method: This method compares the company to similar companies that have recently been sold and uses the sale prices of those companies to estimate the value of the company being valued.
- Precedent Transactions method: This method looks at recent transactions involving similar companies and uses those transactions to estimate the value of the company being valued.
- Income Approach method: This method calculates the value of a company by multiplying the company’s earnings by a price-to-earnings ratio
- Impact on Foreign Investors:
- These changes are specifically aimed at providing relief to prospective foreign investors in Indian startups. Resident investors do not have the option to value equity shares using these five alternative methods.
- Clarity and Reduction of Litigation:
- The amendments to Rule 11UA under the Income Tax Act are expected to bring more clarity to both investors and investees. This clarity will help in selecting an appropriate valuation method, which, in turn, reduces the chances of future litigation related to the valuation of startup investments.
Conclusion
In summary, these amendments to the angel tax provisions aim to make it easier for non-resident investors to invest in Indian startups by offering more valuation methods and providing a tolerance margin for deviations in share valuations. These changes are expected to promote investment in the startup ecosystem and reduce the administrative burden and uncertainties related to valuation.
