The scope of angel tax under Section 56(2)(viib) of the Income Tax Act, 1961 has widened significantly. With amendments introduced via the Finance Act, 2023 and further clarifications through CBDT’s notification dated 25th September 2023, the tax implications now extend to share issuances to non-residents. Rule 11UA has been revised to include additional valuation methodologies for both equity and compulsorily convertible preference shares (CCPS), impacting how startups and private companies approach funding rounds. This blog breaks down the expanded valuation scope, acceptable methods, key exemptions, and compliance considerations that businesses and investors need to understand.
1. Background
Section 56(2)(viib), commonly referred to as the “angel tax” provision, was first introduced in 2012 to curb the practice of issuing shares at inflated values. Originally applicable only to resident investors, the Finance Act, 2023 extended this to cover non-resident share subscriptions as well.
In May 2023, CBDT released a press note proposing new valuation methods, a 10% safe harbour for forex fluctuation, and deemed valuation provisions. These were finalised and codified in Rule 11UA of the Income Tax Rules via Notification No. 81/2023 dated 25 September 2023. The updated rules also now prescribe a framework for valuing CCPS.
2. Additional Valuation Methods for Equity Shares
Previously, the FMV of shares could only be computed using:
- Net Asset Value (NAV) method
- Discounted Cash Flow (DCF) method
Now, for unquoted equity shares issued to non-residents, a merchant banker may also use any of the following valuation methods:
- Comparable Company Multiple Method
- Probability Weighted Expected Return Method
- Option Pricing Method
- Milestone Analysis Method
- Replacement Cost Method
These methods aim to capture the value of new-age businesses that may not have large tangible assets or cash flows but still attract significant investment.
3. Investment at Par with Recognised Entities
To simplify compliance, the rules also provide a deemed FMV where the shares are issued at the same price as that offered to:
a) Notified Persons / Recognised Startups
- Exempt from angel tax, provided the total paid-up capital and premium after issuance does not exceed INR 25 crore.
- If shares are issued at the same price as notified persons, FMV is deemed to be that price, but only if:
- The investment is made within 90 days before or after the notified person’s investment.
- The total consideration does not exceed what the notified entity paid.
b) Venture Capital Funds / Companies / Specified Funds
- If a venture capital undertaking receives investment from such entities, any other investor can be allotted shares at that same price within 90 days, and it will be treated as FMV.
- This rule reduces the burden of repeated valuations for every tranche of investment.
4. Illustration on Valuation Application
A simplified illustration provided in the alert shows:
- Shares issued to a government entity (notified person) at INR 190/share on 1 April 2023 are exempt.
- A private company investing on 1 May 2023 at the same rate is also exempt under the 90-day window.
- If another investor invests within 90 days at a higher rate, exemption is still valid if a VCF invests later at that higher price.
- However, if the issue price exceeds both prior benchmarks, or if the investment is outside the 90-day window, a fresh valuation is required.
5. Safe Harbour and Valuation Report Validity
A 10% safe harbour allows the issue price to exceed FMV by up to 10% if:
- For resident investors: valuation is done using NAV or DCF
- For non-resident investors: any of the six prescribed methods except NAV
Also, a valuation report can be valid for up to 90 days prior to the date of issue, at the option of the assessee.
6. Valuation of CCPS
For compulsorily convertible preference shares, the FMV is determined as follows:
| Investor Type | Accepted Valuation Methods |
| Resident | DCF or same price as issued to a VCF / notified entity |
| Non-resident | Any of the six methods under Rule 11UA (except NAV) |
This flexibility supports a broader range of fundraising structures, especially in startups.
7. Practical Concerns and Industry Implications
- The 90-day time window for using valuation reports can be challenging, especially when multiple funding tranches are involved.
- Judicial rulings (e.g., BLP Vayu Project, Ozone India) have suggested that angel tax should not apply to parent-company investments. However, there’s no official CBDT clarification on this yet.
- Startups face the double burden of FEMA valuation norms (minimum price) and IT Act norms (maximum price), both needing to be satisfied.
- Valuer eligibility differs across regulations, leading to additional cost and compliance complexity.
8. Conclusion
With the expansion of angel tax provisions to non-residents and the inclusion of CCPS, the compliance landscape for private companies has become more demanding. While the additional valuation methods offer flexibility, they also demand rigorous documentation and adherence to new timelines. Companies planning to raise funds from diverse investor classes must tread carefully, ensuring valuation is defensible under both FEMA and Income Tax frameworks.
Startups and VCF-backed ventures should align their funding timelines and pricing structures with the new 90-day validity window, leverage exemptions where applicable, and seek proactive support from tax advisors to avoid unintended tax exposure under Section 56(2)(viib).
