Indian tax department yesterday exempted angel investors from income tax on their investments in startups with effect from April 11. The tax concessions are subject to certain conditions laid down by the Department of Industrial Policy and Promotion (DIPP) last month, which said that the share capital and share premium of the startup should not exceed Rs 10 crore after such investments.

Also the angel investor who plans to subscribe the shares in the start-up will have to fulfill prescribed criteria and the start-up will have to procure a report from a merchant banker, specifying the fair market value of the shares in accordance with income tax rules.

The Income Tax Department, on May 24, issued a notification, superseding its June 2016 notification. “…The Central Government, hereby notifies that the provisions of clause (viib) of sub-section (2) of section 56 of the said Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received for issue of shares from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification,” the Central Board of Direct Taxes (CBDT) said in the May 24 notification.

This notification comes into effect retrospectively from April 11, 2018, it said.

The decision to give investors in startups exemption from income tax was aimed at addressing a key issue faced by angel investors who put money during early growth stage, and would also provide level-playing field for all investors. The Commerce and Industry Ministry had on April 11 said that a start-up can seek tax concession under the section 56 of I-T act. The section 56 provides for taxation of funds received by an entity.

The CBDT has also amended Rule 11 UA (2)(b) of I-T Act, thereby making merchant banker valuation compulsory for the purpose of determining fair market value of unquoted equity shares, and omitted the word 'accountant'.

The notification further said that an angel investor with a minimum net worth of Rs 2 crore or an average returned income of over Rs 25 lakh in the preceding three financial years would be eligible for 100 percent tax exemption on investments made into start-ups above fair market value.

The notification is a welcome move in diminishing the fears of start-ups in relation to angel tax and providing the much-needed clarity with respect to non-applicability of angel tax.

Another key takeaway from the notification, is withdrawal of power from chartered accountants to issue valuation reports for purposes of angel tax. This is perhaps designed to bring in more sanctity to issuance of valuation report.

To recall, in this year's union budget, it was announced that time for claiming a tax holiday/exemption by eligible startups has been extended till 1-April 2021.

Startups and investors were expecting that the government will resolve the issue of angel tax in the this year budget of 2018 however the issue was left out completely.

Thereafter, a new clarification by Finance Secretary Hasmukh Adhia stated that genuine cases of startup valuation as assessed by DIPP will be exempt from paying taxes on angel investments received. However, this will also be applicable only for startups founded before 2016.

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