Where a private limited company issues shares over and above its Fair Market Value (FMV) to an investor resident in India, such excess premium attracts tax under Section 56(2)(viib) of the Income tax Act. (The section treats the difference between the issue prices and FMV as ‘income’.)
However, as a part of Start-up India Scheme, relief from such tax on excess premium is granted to start-ups recognised by the DPIIT and fulfilling certain specified conditions.
Such start-ups are required to file an application in Form 2 along with a declaration on Start-up India Hub which is then forwarded to the Central Board of Direct Taxes (CBDT).
Start-ups seeking exemption from tax on excess premium are required to fulfil three conditions – the primary condition being that start-up is recognised by the DPIIT.
The second condition limits the aggregate amount of paid-up share capital and share premium to ₹25 crore, but excludes shares issued to non-residents, venture capital company/ fund and specified companies.
The third condition says that the share premium money cannot be used for buying things like land and building, vehicle, aircraft, yatch and jewellery, for seven years. It cannot also be used for investing in either equity or debt of other entities.
Techniques for open market valuation
For angel tax exemption, two valuation methods have been prescribed [under Rule 11UA(2) of the Income tax Rules] for determining FMV of unlisted equity shares—net asset value and discounted cash flow.
The former is based on audited financial statements and the latter is determined by Category I Merchant Banker. The start-up may choose one of the two.
On account of the immense potential upside of unique and innovative business ideas, start-ups usually command significantly higher valuation using the DCF method as compared with regular businesses.
Angel tax protection for ongoing proceedings
Form 2 entails a declaration for adhering to necessary underlying conditions and filing the same would render the provisions of Section 56(2)(viib) inapplicable to start-ups.
Further, the CBDT had said that any demands and appeals relating to Section 56(2)(viib) would be dropped.
(The writer is Partner at Nangia Andersen LLP)