Angel tax

How amendments in angel tax will impact companies

Authors

  • KT Chandy

    EY India Corporate Tax and Regulatory Services Partner and Private Tax Co-Leader

  • Surabhi Marwah

    EY India People Advisory Services Partner and Private Client Services Co-Leader

3 minute read 06 Mar 2023
Related topics
Tax
Tax controversy
Private business

Budget attempts to address difference in tax treatment between two similar taxpayers.  

As per  section 56(2)(viib) of the Income Tax Act, 1961, any premium received by a company (other than a public listed company) from a resident, exceeding the Fair Market Value (FMV) of the share issued is liable to tax in the hands of such company.  

This provision was inserted by the Finance Act, 2012 to prevent the circulation of unaccounted money as share premium and is commonly referred to as ‘Angel tax’. Possibly, given that non-resident investors have additional compliances under exchange control, require registrations in  a foreign country, investments by non-residents were kept out of angel tax provisions. While the provisions of this section are applicable to  the issue of all types of shares, issuance of instruments like convertible debentures would not attract the aforesaid provisions.

In contrast to the expectation that the government would grant relief to resident investors by repealing Angel tax, the government has sought to bring in parity in taxation by extending the provisions to non-resident investors. The Finance Bill, 2023, now proposes to remove the condition of residency from the section, making it applicable even when shares are being issued to non-resident investors. This amendment would impact shares issued and consideration received on or after 1 April 2023.

As per the foreign exchange pricing guidelines in India, shares issued to non-resident investors cannot be below the FMV of the shares, which acts as a pricing floor. Angel tax now seeks to tax any amount received more than FMV as income in the hands of the company. As a result, the only tax efficient option for a company would be to procure investment at the exact FMV of the shares, which could impact the price negotiations of an investment. 

The proposed amendment may deter foreign investors from investing in India and lead some start-ups to consider restructuring their holdings overseas to avoid pressure from concerned foreign investors. Nonetheless, the Indian government has introduced certain measures to facilitate and encourage foreign investment in Indian companies.

Exemption under this section would be available to recognized start-ups (which have filed a declaration in Form 2 with the DPIIT) issuing shares to resident and non-resident investors. Further, as is the case presently, investment in Indian companies through specified funds like AIFs would remain outside the ambit of this section.

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The start-up sector needs an enabling policy environment, particularly amidst the current global headwinds.  Considering this, the government may consider withdrawing the proposed amendment to section 56(2)(viib). 
 

Alternatively, specific exemption under this section may be provided to:
 

  • Non-resident entities registered with Reserve Bank of India (RBI)/ Securities Exchange Board of India (SEBI) equivalent regulatory authorities in their respective countries, e.g., entities coming from Financial Action Task Force whitelist jurisdictions;
  • Entities/ funds qualifying as Category I Foreign Portfolio investors under SEBI FPI Regulations 2019, even if not registered with SEBI; and
  • Direct/ Indirect investment by sovereign wealth funds and pension funds qualifying as per definition u/s. 10(23FE) even if not notified as “specified person” u/s. 10(23FE)
     

Further, safe harbour mechanism/ tolerance limit up to 25% may be provided where shares are issued at a price higher than valuation report by category - I merchant banker.  Any valuation disputes beyond the 25% tolerance limit should first be referred to an approval panel (just as in the case of GAAR) for a fair evaluation of the case. 
 

These amendments, if carried out without any exemptions, may force the unlisted Indian companies to consider alternatives which could be explored to alleviate the impact of the proposed amendment. The companies could expedite and finalize any fund raise from foreign investors, which is in the pipeline, such that the infusion is completed on or before 31 March 2023 as the amendment would only come into effect from 1 April 2023. Investors could also look at viable options to register and operate in India through AIFs, at least for their India investments. 
 

This article is also co-written by Vinay K, Director, Private Tax, EY India.

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Summary

The proposed removal of residency conditions in ‘Angel tax’ could impact shares issued and consideration received on or after April 1, 2023. Although the Indian government has provided some exemptions for recognized start-ups and specified funds, the proposed amendment could reduce the allure for foreign investors looking to invest in India and force certain start-ups to consider having their holding structure overseas to avoid the impact of the proposed amendment.

About this article

Authors

  • KT Chandy
    EY India Corporate Tax and Regulatory Services Partner and Private Tax Co-Leader
  • Surabhi Marwah
    EY India People Advisory Services Partner and Private Client Services Co-Leader
Related topics
Tax
Tax controversy
Private business

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