Valuation rules to be reviewed for Angel Tax on foreign Investments

India will investigate the valuation rules for the so-called ‘angel tax’ on investments by overseas investors in start-ups.

A senior official said the government is examining the different valuation criteria prescribed under two separate laws which could lead to disputes and litigations. Such overseas investment is valued differently under the Foreign Exchange Management Act (FEMA) and the Income Tax Act.

“This would be examined. It could be clarified through rules as well,” the official said.

The government has proposed an amendment the angel tax provision or section 56(2) (viib) of the Income Tax Act in the budget.

The angel tax is levied when an unlisted company issues shares at a price that exceeds the fair market value. The difference is taxed at 20% or more.

The government has now proposed to bring foreign investors under the ambit of the angel tax which hitherto applied to Indian residents and funds not registered as Alternative Investment Funds (AIFs).

Experts said this could scare away growth capital and there could be valuation disputes as different methodologies are prescribed under different statutes.

Also read: ETtech Explainer: Has the Budget 2023-24 resurrected 'angel tax'?

“The moot point is that valuation of any business is an estimate based on multiple futuristic presumptions, which may or may not materialise,” said Vikas Vasal, national managing partner, tax, Grant Thornton Bharat. “Therefore, it’s difficult to build on this premise in any computation mechanism

“A peculiar issue is that our foreign exchange laws set a minimum floor (the Fair Market Value for getting FDI, whereas u/s 56(2)(viib) the tax authorities treat the FMV is treated as a ceiling beyond which, if you go, the differential is taxed,” said Amit Maheswari, partner, AKM Global.

Maheshwari pointed out that under both FEMA and Income-tax typically, discounted cash flow method would be used, and this presented a dichotomy.

This provision, termed an anti-abuse measure, was introduced by former finance minister Pranab Mukherjee in 2012, but it snowballed into a major issue for startups after many were slapped with notices.

The government subsequently gave relief to the start-ups registered with the Department for Promotion of Industry and Internal Trade (DPIIT).

The government has reiterated that startups registered with the DPIIT will continue to enjoy relief, but for many unrecognised startups that are largely foreign funded, the provision could add to funding challenges amid a difficult environment.

“This proposed amendment has the potential to make life even more difficult for cash-starved startups, especially considering the fact that we are in the midst of funding winter,” Maheshwari said.