When startups raise funding, they’re not just thinking about how much they’re getting — they’re also thinking about what they’re giving up and how it’ll be taxed. And for years, there was a big problem with this: angel tax. It was one of those things that quietly discouraged early-stage investment, especially when startups issued shares at a premium.
In Part 3 of the M2K Startup Series, we’re going to unpack this issue. More importantly, we’ll explain how the government addressed it, what changes were made, and what startups need to do to make sure they don’t end up paying tax on capital they raise.
Let’s break it down.
Angel Tax Exemption
Back in 2012, a rule was introduced that ended up hitting startups pretty hard. Whenever a closely-held company — that is, one not publicly listed — issued shares at a premium to Indian residents, and the issue price was more than what the shares were worth (the fair market value), the excess was considered as income.
That extra amount? It was taxed. And not lightly. It was taxed under the head “Income from other sources” — not as capital, not as business revenue — as if the startup earned it in some unrelated way.
Let’s take a simple example:
| Face Value | Issue Price | FMV | Taxable Income |
| 100 | 200 | 150 | 50 |
| 100 | 150 | 150 | 0 |
So in the first row, even though investors paid ₹200, the company had to pay tax on ₹50. Not great when you’re just trying to grow.
To fix this, the Department for Promotion of Industry and Internal Trade (DPIIT) issued a notification in February 2019, saying that startups would be exempt from angel tax — if they met certain conditions.
We’ll now look at those conditions in full.
Conditions to be satisfied by Startup
There are a few things your startup needs to have in place before you can get this exemption. Here’s the first set.
- Recognition by DPIIT is a must. If your startup hasn’t been formally recognised by DPIIT, you can’t even apply for this exemption.
- After issuing the new shares, your startup’s total paid-up capital plus share premium must stay within ₹25 crores.
Here’s where it gets interesting: not all investors are counted in that ₹25 crore limit. If you’re raising funds from the following, you don’t have to count their shares when calculating the total:
- Non-residents (foreign investors)
- Venture capital funds or companies
- Specified listed companies
This part of the rule is actually very founder-friendly. It means a startup can still raise more than ₹25 crores — but only from these exempted investor categories — and still be eligible for the tax break.
The second part of the condition isn’t about how much money you raise, but rather what you do with it.
Once the shares are issued at a premium, your startup must not invest in certain assets for seven years, starting from the end of the financial year in which the shares were issued.
Here’s the list of assets you can’t touch:
- Motor vehicles, yachts, aircrafts, or anything similar that costs more than ₹10 lakhs — unless you’re renting it out, hiring it, leasing it, or selling it as part of your business.
- Loans and advances, unless lending is part of your regular business activity.
- Shares, securities, jewellery, and similar investments — unless they’re held as stock-in-trade.
- Capital contributions to other entities — no putting money into other businesses.
- Land or buildings, whether commercial or residential — unless they’re rented out or meant to be sold.
- And finally, anything rare or collectible: paintings, sculptures, antiques, bullion, and similar.
Basically, the government wants to make sure the money raised from angel investors is being used to grow the startup — not being diverted into passive assets.
Approval process
Once your startup has met all the conditions above, here’s how the exemption process works.
You don’t need to wait around for CBDT approval. There’s no formal clearance required from the Income Tax Department.
Instead, your startup just needs to file a declaration in Form 2 with DPIIT, stating that it meets the criteria for exemption. Once you do that, DPIIT sends it to CBDT (Central Board of Direct Taxes) for their records.
But here’s something to be careful about: if your startup does invest in any of the restricted assets within the 7-year window, the exemption gets revoked — and not just going forward, but with retrospective effect.
That means the tax benefit could be cancelled for previous years too. Which could turn into a serious liability.
So the rule is simple: get the exemption, and then stay compliant for the next seven years.
Final thoughts
The angel tax might have been introduced with good intentions, but for years, it discouraged genuine investment in India’s startup ecosystem. Recognising that, the 2019 DPIIT notification brought real relief — but with clear guardrails.
If you’re running a startup and planning to raise funds at a premium, this exemption is something you can’t afford to ignore. But don’t take it lightly either. Every condition needs to be checked, documented, and complied with — not just during the fundraising round, but for years after.
Before filing Form 2, make sure:
- You’re DPIIT-recognised
- You’re under the ₹25 crore cap (excluding exempt investors)
- You have no investment plans in the restricted asset classes
And once that’s done — raise confidently. You’ll have the funds you need without the tax hit you don’t deserve.
