June 01, 2018
TaxBuzz - Expansion of eligible ‘Investors’ for exemption from ‘Angel Tax’ on investment in Start-Ups
‘Startup India’ is a flagship initiative of the Government of India, intended to build a strong eco-system for nurturing innovation and Startups in the country through innovation and design. In order to meet objectives of the Startup initiative, the Government of India announced Action Plan addressing all aspects of the Startup ecosystem on 16th January 2016.
One area of concern expressed by the ‘Startup’ community related to applicability of the provisions of section 56(2)(viib) of the Income Tax Act, 1961 (“the Act”) on fresh issue of shares by the company to angel investors at premium {in excess of fair market value (“FMV”)}, popularly known as ‘Angel Tax’. The proviso to said section grants exemption from applicability thereof, if the shares are issued to a notified class or classes of persons.
Vide Notification No. 45/2016, dated 14th June, 2016, ‘class of persons’ for the aforesaid purpose were notified to mean a ‘resident’ person investing in the shares of a ‘Startup’ company. 'Startup' company was defined as an entity (a) incorporated as a private limited company or a partnership firm or a limited liability partnership in India, upto seven years from the date of incorporation for all sectors except biotechnology and upto ten years for biotechnology sector; and (b) having turnover below Rs.25 crores in all financial years; and (c) pursuing the objectives of 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. Further, the company satisfying the aforesaid conditions had to be approved as a ‘Startup’ by the Inter Ministerial Board of Certification (‘the Board’) constituted by the Government.
Vide Notification No 364(E) dated 11th April, 2018, Department of Industrial Policy and Promotion (“DIPP”) outlined the process for obtaining approval for fresh issue of shares by a Startup to the eligible investor from the Board, for purposes of availing exemption under the aforesaid proviso to section 56(2)(viib) of the Act. The said Notification, interalia, prescribed the condition for such approval as – (i) the aggregate amount of paid up share capital and share premium, after the proposed issue of shares does not exceed Rs. 10 Cr; and (ii) 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.”) (Refer our TaxBuzz dated April 19, 2018).
In furtherance to the above, the CBDT has now issued Notification No. S.O. 2088(E) dated 24th May, 2018, amending the aforesaid notified category of ‘a class of persons’ from ‘resident person’ to ‘any investor’ (i) investing in the shares of a Startup duly approved by the Board; and (ii) satisfying the following financial conditions:
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the investor must have an average returned income of Rs.25 lakhs or more in the preceding three financial years; or
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the investor must have a net worth of Rs.2 crores or more as on the last date of the preceding financial year.
The aforesaid Notification has been prescribed to come into effect retrospectively w.e.f. 11th April, 2018.
Further, as per the existing provision of section 56(2)(viib) of the Act read with Rule 11U/UA of the Rules, the exercise of determination of FMV of unquoted equity shares has to be conducted either by a ‘merchant banker’ or a ‘chartered accountant’. Having regard to the earlier Notification of 11th April, 2018, whereby fresh issue of shares by a Start-up supported with valuation report from merchant banker only was exempted under the proviso to section 56(2)(viib) of the Act, vide Notification No. S.O. 2087(E) dated 24th May, 2018, the CBDT has amended Rules 11U/11UA to restrict the acceptable category of valuers as ‘merchant banker’ only, thereby ousting valuation report of a ‘chartered accountant’ for the purposes of section 56(2)(viib) of the Act. The notification provides that the said amendment shall come into force from the date of its publication in the Official Gazette.
Comments/ Observations
The aforesaid Notification issued by the CBDT provides that eligible investors, fulfilling the parameters and approved by the Board shall be eligible for availing exemption from the application of section 56(2)(viib) of the Act on investment in a Startup. Although, the Notification restricts the scope of aforesaid eligible investors to those fulfilling the prescribed financial criteria, the said criteria are liberal and should not adversely impact the sizeable community of investors.
With regard to the second aspect covered in the said Notification by way of amending Rules 11U/UA ousting valuation reports issued by a ‘chartered accountant’ for the purposes of computing FMV under section 56(2)(viib) of the Act, the same, in our view, is discriminatory especially considering that such valuation reports prepared by chartered accountants for fresh issue of shares are acceptable under the Companies Act or FDI/RBI guidelines. As per the earlier Notification of 11th April, 2018, valuation report from merchant banker was required only in case of fresh issue of shares by a Start-up for the purposes of availing exemption under the proviso to section 56(2)(viib) of the Act, whereas the present amendment shall be applicable to fresh issue of shares by all the companies, including Start-ups.
In this connection the Institute of Chartered Accountants of India (‘ICAI’) has also made representation before the CBDT to reconsider exclusion of chartered accountants from the acceptable category of valuers for the purposes of section 56(2)(viib) of the Act. (refer ICAI letter dated 29th May, 2018 filed with the CBDT)
Further, considering that the said amendment is to come into force from the date of publication of Notification in the Official Gazette, issue may arise with respect to acceptability of valuation reports issued by a ‘chartered accountant’ prior thereto; in other words, whether the said amendment will have prospective or retrospective application?
As per the accepted principles of interpretation, procedural amendments have retrospective effect, whereas substantive amendments can only have prospective effect. Accordingly, issue may arise as to whether the valuation reports issued by a ‘chartered accountant’ prior to the said amendment shall be acceptable for computing FMV of shares under section 56(2)(viib) of the Act?
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