If you've followed startup news in India over the past decade, you've likely heard the term 'angel tax' - a provision that taxed a startup's share premium as income if shares were issued above fair market value. It became a major point of friction between startups and tax authorities, led to a specific exemption mechanism for DPIIT-registered startups, and has seen significant policy changes. Here's the full picture.
What Was 'Angel Tax' Under Section 56(2)(viib)?
Section 56(2)(viib) provided that where a closely-held company (a company in which the public is not substantially interested) issues shares to a resident at a price that exceeds the fair market value (FMV) of those shares, the excess (share premium above FMV) is taxable as "Income from Other Sources" in the hands of the company receiving the funds.
The tax fell on the company raising funds, not the investor. This is a key point that often confused founders - angel tax under 56(2)(viib) taxed the startup/company issuing the shares on the excess premium received, treating it as the company's income, rather than taxing the investor. This meant that a startup raising capital at a valuation tax authorities considered "too high" relative to a computed FMV could face a tax demand on the difference - even though that money was raised as equity capital, not revenue.
How Was "Fair Market Value" Determined?
| Method | Basis |
|---|
| Net Asset Value (NAV) method | Based on the book value of the company's assets and liabilities |
| Discounted Cash Flow (DCF) method | Based on projected future cash flows, certified by a merchant banker |
The taxpayer (company) could generally choose between these prescribed methods, and the FMV so determined was compared against the actual issue price of shares to determine if a premium in excess of FMV existed.
The DPIIT-Registered Startup Exemption
Recognized startups got relief - subject to conditionsTo address widespread concerns from the startup ecosystem, the government provided that Section 56(2)(viib) would not apply to consideration received by a company for issue of shares, if the company is a recognized "startup" (as notified by the Department for Promotion of Industry and Internal Trade - DPIIT), subject to conditions, including limits on the aggregate amount of paid-up share capital and share premium after the proposed issue, and restrictions on investing the proceeds in certain categories of assets (like land/buildings not used for business, loans/advances, capital contributions to other entities, etc., subject to specified exceptions).
Extension to Non-Resident Investors
Originally, Section 56(2)(viib) applied only when shares were issued to a resident. At one point, this was extended to also cover consideration received from non-resident investors (such as foreign venture capital funds and other foreign investors), which significantly expanded the provision's reach and raised concerns for startups receiving foreign funding.
Current Status: Angel Tax Abolition
Section 56(2)(viib) was abolished for shares issued on or after 1 April 2024 (i.e., applicable from Assessment Year 2025-26 onwards) - meaning the angel tax provision, as it previously existed, no longer applies to share issuances made on or after this date. This was a significant relief for the startup ecosystem, removing a long-standing point of friction around startup valuations and fundraising. Companies should note that this abolition applies prospectively - share issuances that occurred before 1 April 2024 remain subject to the provision as it existed at that time, including any ongoing assessments or disputes relating to those earlier issuances.
Why This Matters Even After Abolition
- Past assessments and litigation: Many startups that issued shares before 1 April 2024 may still have open assessments, appeals, or notices relating to angel tax on those historical share issuances - the abolition does not automatically resolve pending disputes for pre-2024 transactions.
- Historical context for valuations: Understanding how FMV was computed and disputed under this provision remains relevant for startups dealing with legacy fundraising rounds.
- DPIIT registration still matters for various other startup-specific tax benefits (such as tax holiday provisions under Section 80-IAC), even though its specific relevance to angel tax has diminished with the provision's abolition.
Frequently Asked Questions
Our startup is DPIIT-registered and raised funds in FY 2023-24 at a valuation that an assessing officer claims exceeds fair market value under the DCF method. Does the abolition of angel tax from FY 2024-25 help us with this past issue? ▼
No, not directly. The abolition of Section 56(2)(viib) applies to shares issued on or after 1 April 2024 (FY 2024-25 / AY 2025-26 onwards). For share issuances that occurred in FY 2023-24 (before this date), the provision as it existed at that time - including the DPIIT-registered startup exemption (if your company met its conditions) - would continue to apply, and any assessment, notice, or dispute relating to that issuance would be evaluated under the law as it stood then. If your company met the DPIIT-registered startup exemption conditions at the time of the FY 2023-24 issuance, that exemption (separate from the general abolition) may still be relevant to your defense in any ongoing proceedings. Consult a Chartered Accountant/tax counsel experienced in startup taxation for guidance on the specific assessment.
Does the abolition of angel tax mean foreign investors can now invest in Indian startups at any valuation without any income tax consequences for the startup? ▼
For share issuances made on or after 1 April 2024, Section 56(2)(viib) (which had been extended to cover non-resident investor consideration) no longer applies, removing this specific income tax concern for the issuing company on share premium from both resident and non-resident investors. However, this doesn't mean valuations are entirely free of regulatory consideration - other regulations (such as FEMA pricing guidelines for share issuances to non-residents, which require issue price to not be less than fair value as per specified methods) may still impose their own valuation-related requirements, separate from the income tax angle. It's advisable to consider both income tax and FEMA/RBI compliance angles for foreign investment transactions.
How was 'fair market value' actually disputed in practice under the old angel tax provision - was it just a matter of picking DCF vs NAV? ▼
While the company could choose between the NAV and DCF methods (with DCF requiring certification by a merchant banker), disputes commonly arose over the assumptions and projections underlying the DCF valuation - assessing officers would sometimes challenge growth rate assumptions, discount rates, or terminal value calculations used by the merchant banker, arguing that the resulting FMV was inflated relative to the actual issue price's premium. This led to considerable litigation over what constituted a 'reasonable' valuation methodology for early-stage companies with limited operating history, which was one of the core criticisms of the provision and a key driver behind both the startup exemption and the eventual abolition.