Centre Softens Angel Tax Rules

Relevance: GS2 - Government policies and interventions for development in various sectors and issues arising out of their design and implementation; GS3 - Indian Economy, Effects of liberalization on the economy

(Source: The Hindu, 09/27/2023)

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Why in the news?

Recently, the Income Tax Department has notified new angel tax rules that comprise a mechanism to evaluate the shares issued by unlisted startups to investors

Background

• The Finance Act, 2023 made amendment to bring the consideration received from non-residents for issue of shares by an unlisted company within the ambit of section 56(2)(viib) of the Income-tax Act, 1961.
• If this consideration exceeds the Fair Market Value (FMV) of the shares, it is taxable under "Income from other sources." Rule 11UA outlines how to compute the FMV of such shares.
• Following this amendment, the Central Board of Direct Taxes (CBDT) released a draft notification, inviting suggestions/comments on the proposed changes to Rule 11UA.
• Now, the CBDT has issued the Income-tax (Twenty-First Amendment) Rules, 2023, amending Rule 11UA.

Understanding section 56(2)(viib) of the Income Tax Act

• Section 56(2)(viib) of the Income Tax Act provides that where a closely-held company issues shares to a resident investor at a value higher than the “fair market value” of such shares, then the excess of the issue price over the fair value will be taxed as the income of the issuer company.
• Rule 11UA or of the Income-tax Rules provides the formula for the computation of the fair market value of unquoted equity shares for the purpose of section 56(2) (viib) of the Act.

Key Changes in Rule 11 UA

• The Central Board of Direct Taxes issued a notification, amending Rule 11UA under the Income Tax Act, incorporating changes to the draft norms released earlier.
• In addition to the two methods for valuation of shares, namely, Discounted Cash Flow (DCF) and Net Asset Value (NAV) method, available to residents under Rule 11UA, five more valuation methods have been made available for non-resident investors, namely,
  • Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, Replacement Cost Method.

• It offers a 10% tolerance for deviations from the accepted share valuations.
• When shares are issued to non-resident entities notified by the Central Government, the Fair Market Value (FMV) of the equity shares corresponding to the consideration received can be used as the valuation basis for both resident and non-resident investors.

What is Angel Tax?

• The angel tax is a 30% tax on any excess funds raised by an unlisted firm through the issuance of shares over and above the shares' fair market value.
• It typically impacts start-ups and their ‘angel’ investors and is taxed because it is viewed as corporate income.
• The angel tax was implemented in 2012 under section 56(2)VII B of the Income Tax Act,1961.
• Earlier, it was imposed only on investments made by a resident investor, but Budget 2023-24 proposed to extend angel tax even to non-resident investors from April 1, 2024.

Why was Angel Tax introduced?

• The government introduced the Angel Tax to curb money laundering and make it easier for businesses to comply with the tax norms.
• The angel tax is levied on unlisted businesses or startups on the funding they get from the angel investors.
  • An angel investor is an individual with a high net worth willing to provide financial backing for small startups and entrepreneurs.
  • Angel investors give financial assistance in exchange for ownership equity in the company.

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FAQs

MCQ

Question: Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (UPSC 2019)

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note