April 19, 2018

TaxBuzz - Relief from ‘Angel Tax’ to Startups - Notification by CBDT

In a further move to encourage startups in the country, the Government has issued notification dated April 11, 2018 to grant certain tax incentives to startups as part of the Government’s ‘Startup India’ initiative.

Section 56(2)(viib) of the Income Tax Act (“the Act”) provides that, where a closely held company issues shares at a price more than the fair market value (“FMV”) of such shares, the amount received in excess of FMV will be deemed as ‘income from other sources’.

The ‘Startup’ community had expressed concern regarding applicability of the aforesaid provisions of section 56(2)(viib) of the Act, popularly known as ‘Angel Tax’.

Addressing the aforesaid concern, the Central Board of Direct Taxes (‘CBDT’) had earlier vide notification dated February 06, 2018 granted interim relief from such angel tax by directing the taxman to not undertake coercive steps in recovering pending taxes from startups under the provisions of section 56(2)(viib) of the Act. (Refer our TaxBuzz dated February 09, 2018).

The proviso to sub section (viib) of section 56 provides for exemption of the aforesaid provisions to certain notified class or classes of persons.

As a sequitur to the relief measures to startup, the Department of Industrial Policy and Promotion (“DIPP”) has issued Notification No 364(E) dated 11 April, 2018, thereby laying down the norms for notification of startups for the purposes of aforesaid proviso to section 56(2)(viib) of the Act.

The salient features of the aforesaid notification are as under:

  • Definition of a Startup:

An entity shall be considered as a startup:

  1. Upto a period of seven years from the date of incorporation/registration, if incorporated as a private limited company or registered as a partnership firm or a limited liability partnership in India, if the organization is engaged in any business other than, in the business of biotechnology;
  2. In case of startups engaged in the business of biotechnology sector, the period shall be upto ten years from the date of its incorporation/ registration;
  3. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded Rs. 25 crore; and
  4. The entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
  • Eligibility criteria for notification of startup under proviso to section 56(2)(viib) of the Act:
  • A private limited company, which meets the definition of startup above, shall be eligible to apply for notification under section 56(2)(viib) of the Act, if the following conditions are satisfied:
  • the aggregate amount of paid up share capital and share premium, after the proposed issue of shares does not exceed Rs. 10 Cr.;
  • the investor/ proposed investor who proposed to subscribe to the issue of shares of the startup (‘the investor’), has
  • the average returned income of Rs. 25 lakhs or more, for the preceding three financial years; or
  • the net worth of Rs. 2 crores or more, as on the last date of the preceding financial year; and
  • the Startup procures a report from a merchant banker, specifying the FMV of shares in accordance with Rule 11UA of the Income Tax Rules, 1962 (“the Rules.”)[1]
  1. The application for approval shall be made in Form-2 to the Inter Ministerial Board (‘the Board’), accompanied by the documents specified therein.
  1. The Board may, after calling for such documents or information and making such enquiries, as it may deem fit, —
  2. grant approval for the purposes of proviso to clause (viib) of sub-section (2) of section 56 of the Act, specifying the relevant details, including details of investor, amount of premium on which shares are to be issued, and the latest date by which the shares are to be issued; or
  3. decline to grant the said approval after providing reasons.

Comments/ Observations

The aforesaid notification has brought necessary respite from angel tax to startup companies seeking fresh investments from angel investors in its business. To that extent, it is a welcome move by the Government, however, looking at the size of businesses being commenced by various startup companies in this modern era of technology/ Digital Economy, the cap on the post issue of share capital of Rs. 10 crores is quite low and may not be applicable to many innovative startup companies. Accordingly, it is anticipated that the aforesaid cap may be revised to a more reasonable amount.

For any details and clarifications, please feel free to write to:
Mr. Gaurav Jain[email protected]

[1] The notification provides for procurement of a report from a merchant banker, in support of the valuation of shares so arrived, in accordance with the methods prescribed under Rule 11UA of the Rules, which amongst others, considers the discounted free cash flow (DCF) method to be an acceptable method of valuation.