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Startups have become an important pillar of our ecosystem, and one of the most prominent ways to invest in startups is through angel investing. Hon. Finance Minister Smt. Nirmala Sitharaman, while presenting the budget, proposed some important amendments to the ‘Angel Tax’.
In this edition of Taxation Times, we will go through the amendments made by the Union Budget 2023 in ‘Angel Tax’.
In this month’s Taxation Times, we cover:
We hope that you find this month’s edition of the Taxation Times useful. In case you have any feedback or need us to include any information to make this issue more informative, please feel free to write to us at info@uja.in.
Happy Reading!
Best Regards,
UJA Tax Team
Angel taxation, a provision under Section 56(2)(viib) of the Income Tax Act, 1961, has long been a contentious issue for startups and angel investors in India. It aimed to curb the misuse of share premiums by closely held companies to evade taxes. However, this provision had unintended consequences, stifling investment in early-stage businesses and hindering the growth of the startup ecosystem. Recognizing these challenges, the Indian government introduced significant amendments to angel taxation to create a more startup-friendly environment. In this article, we will explore the key amendments made to the angel taxation provisions and their implications for startups and angel investors.
In 2023, the Indian government took a significant step towards fostering a conducive environment for startups and angel investors by introducing crucial amendments to the Angel Taxation provisions under Section 56(2)(viib) of the Income Tax Act, 1961. The changes aimed to address the challenges faced by startups in raising capital and reducing the burden of compliance, encouraging more investments in early-stage ventures. In this article, we will explore the key amendments made in 2023 to Angel Taxation and their potential impact on the startup ecosystem in India.
Memorandum to Finance Act 2023 states that Section 56(2)(viib) of the Income Tax Act 1961 (‘the Act’) was inserted by Finance Act, 2012, to prevent the generation and circulation of unaccounted money through share premium received from resident investors. The 2023 amendment, however, included the consideration received from a non-resident also under the ambit of Section 56(2)(viib) by removing the phrase ‘being a resident’ from the said clause.
The amendment reiterated the original objective of expanding the scope of Section 56(2)(viib) without providing a rationale for the same. The modus operandi exercised by tax authorities in enforcing this provision renders the original objective peripheral and irrelevant. Investors have been receiving notices from the department examining their creditworthiness, despite the fact that the source of funds was never in doubt. The manner in which Section 56(2)(viib) is being applied is without any regard to its original intention, i.e., preventing the circulation of black money.
The term ‘angel tax’ now seems like a contradiction by and of itself, as we discuss angels on the one hand and tax them on the other. In order to analyse the ramifications of the new provisions, let us briefly look at the changes introduced in the Finance Act 2023 and subsequent notifications vis-à-vis the erstwhile provisions.
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Pre – Amendment |
Post – Amendment |
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Only ‘resident’ investors were covered |
Both ‘resident’ and ‘non-resident’ investors were covered |
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Rule 11UA: Only two methods 1. DCF (Discounted Cash Flow) 2. NAV (Net Asset Value) method |
Five additional valuation methods are provided under Draft Rule 11UA for non-residents aligning with FEMA 1. Comparable Company, Multiple Methods 2. Probability-Weighted Expected Return Method 3. Option Pricing Method 4. Milestone Analysis Method 5. Replacement Cost Methods |
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Exclusions: DPIIT-registered start-ups (meeting specified conditions) The amount of paid-up capital does not include funds from non-residents and venture capital funds |
Exemption from Angel Tax is extended to ‘notified entities’ from ‘Specified Nations’ |
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Price Matching Method is not available |
Price Matching for both resident and non-resident investors |
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Safe Harbour is not available |
Safe Harbour for both resident and non-resident investors |
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A contemporaneous valuation report is required, but no time period for validity is specified |
90 days are specified as the time period for the validity of the valuation report (at the option of the assessee) |
As the amendment is proposed to be effective on April 1, 2023, it would be worthwhile to see if companies in the interim accelerate their investment plans, which would increase foreign investments.
The valuation adopted by the companies will be under closer scrutiny from the tax authorities. Various deals and negotiations that take place on business structuring may vex non-resident investors and have an impact on the deal’s value. The Indian company or promoter group may also be impacted, as in the new era of dynamic business, the valuation determined based on one of the methods (i.e., net asset value or discounted cash flow) could be very subjective. At times, the actual value would be way different from the valuation reports. In the new era, companies and founders used to take advantage of this uncertainty by using a higher value while taking investments from non-residents and, in turn, offering less equity. The proposed amendment takes away this arbitrage, and the companies or founders need to dilute more or agree to pay taxes.
The amendments made to the Angel Taxation provisions under the Income Tax Act, 1961, in 2023 mark a significant milestone in India’s journey to create a vibrant and thriving startup ecosystem. The removal of the Angel Tax for DPIIT-recognised startups, the increased investment limit, and expanded accredited investor norms are bold steps towards encouraging innovation and entrepreneurship. These changes are expected to boost startup funding, attract global investments, and position India as a hotspot for innovation in the years to come. As the startup ecosystem continues to evolve, it is imperative for the government to stay engaged with stakeholders and consider further refinements to support the growth and success of startups in India.
Facts: The assessee company is a Foreign Company. It is a tax resident of the USA. It had filed the income tax return for the relevant year, and the case was selected for scrutiny under CASS, and the Ld. Assessing Officer (The Ld. AO) completed the assessment and accepted the return filed by the assessee company.
In the exercise of powers vested in him under Section 263 of the Act, the Ld. CIT cancelled the said assessment order, holding that the same is erroneous and prejudicial to the interest of Revenue as the assessee company received the sum from customers in India on which, though tax was deducted at 10% at the time of remittances, the same was not offered to tax in India. He also observed that during the course of assessment proceedings, no details were called for with regard to ascertaining the taxability of these receipts. Accordingly, the Ld. CIT directed the Ld. AO to revise the assessment order.
Aggrieved, the assessee company brought an appeal before the Tribunal, and all the grounds related thereto.
Held: Assessee, a tax resident of the USA, engaged in the business of maintaining an on line database pertaining to legal and law-related information and earned subscription fees from customers worldwide, including India, by providing access to the database. Assessee filed its return of income claiming that the subscription fee received for providing access to the database was in the nature of business income and was not taxable in India as per the provisions of the India-US DTAA as it did not have a fixed place of business or a PE in India. Assessment was completed under Section 143(3) on total returned income. The Commissioner, however, held that the assessment order was erroneous and prejudicial to the interest of revenue as a relevant inquiry to ascertain facts and taxability of income had not been conducted. Consequently, the Commissioner examined the merits of the case and concluded that the income of the assessee was taxable as FTS or FIS under the provisions of the Act in conjunction with Article 12(4) of the India Accordingly, the Commissioner directed the Assessing Officer to revise assessment order. However, it was found that the Tribunal in subsequent two assessment years in the assessee’s own case decided this issue on merits in favour of the assessee, holding that in the absence of any material available on record to prove that the assessee was providing full-fledged service and solutions for legal professions, a payment received by the assessee was in the nature of business profit, which could not be brought to tax in India in the absence of PE.
In Favour of: The Assessee
Facts:
The assessee is a company organised under the laws of the USA. It had a 100% subsidiary in India by the name of J.P. Morgan Services India Pvt. Ltd. (“subsidiary”). The subsidiary carried on the business of providing back-office support services in the nature of Information Technology and Information technology-enabled services to the assessee’s group entities across the world.
During the assessment year 2019–20, the assessee subscribed to equity shares issued by the subsidiary. The assessee was allotted certain equity shares at a premium of a certain sum. It remitted an aggregate amount from outside India to its subsidiary in two branches. The premium was ascertained based on a valuation report issued by the accredited valuers. The assessee also submitted the necessary details to RBI, and RBI, by an auto-generated email dated October 23, 2018, approved the assessee’s reporting form.
The assessee received a notice from the department under Section 148A(b), calling upon the assessee to show cause as to why a notice under Section 148 should not be issued to the assessee.
The assessee explained, inter alia, that in the absence of any income chargeable to income tax, there was no question of income escaping assessment during the year under consideration. It gave a detailed account of its background and that of the subsidiary, etc., and also furnished copies of the Foreign Inward Remittance Certificate, share certificates issued by the subsidiary in the name of Central Depository Services (India) Limited (CDSL), the Valuation Report, etc.
The department passed an order under Section 148 of the Income Tax Act, 1961.
Aggrieved by the order passed by the Ld. AO, the assessee filed a writ petition before the Hon. High Court.
Held:
Assessee was a company organized under the laws of USA – It had a 100% subsidiary in India – Subsidiary carried on business of providing back-office support services in nature of Information Technology to assessee’s group entities across world – During assessment year 2019-20, assessee subscribed to equity shares issued by subsidiary – Assessee was allotted certain equity shares at a premium of certain sum – It remitted an aggregate amount from outside India to its subsidiary in two branches – Premium was ascertained based on a valuation report issued by accredited valuers – Assessee also submitted necessary details to Reserve Bank of India (RBI) – RBI by an auto generated mail approved reporting form of assessee – Department however, issued notice under section 148 A for reopening assessment on ground that assessee had not submitted any documentary evidence to verify source of investment and accordingly, income escaped assessment for relevant year – Whether since assessee had necessary permission from RBI and if RBI had any doubts about assessee’s genuineness or source of funds, it would have red flagged assessee or subsidiary, therefore, it could be said that department had not applied mind to matter at hand Held, yes. Whether further revenue had failed to appreciate that assessee was a company organized under relevant laws of the USA and was subject to tax in the USA, with income running into billions of dollars, and the assessee had been filing its financial results with the Federal Reserve as per the Bank Holding Company Act, which was in the public domain, which goes to show that assessee had sufficient funds to make investments in subsidiaries during the year in consideration. The order passed under section 148A(d) was to be quashed and set aside and the matter would be remitted back to revenue but the officer who would consider the matter would be someone different from one who had passed the impugned order.
In Favour of: The Assessee
Facts:
The assessee company received an intimation from ADIT, CPC, Bangalore (hereinafter referred to as A.O.) u/s 143(1) of the Act, wherein the business income has been increased on account of the disallowance of late payment of PF and ESI Rs. (Employee’s Contribution).
Aggrieved by the intimation received, the assessee company filed an appeal before CIT (A). The Ld. CIT (A) upheld the additions made by the intimation order and passed the order accordingly.
Aggrieved by the appellate order passed by the Ld. CIT (A), the assessee company filed an appeal before the Hon. ITAT.
Held:
The assessee made payment towards employee’s contribution towards EPF and ESI; Assessing Officer disallowed same on the ground that deposit of contribution towards EPF and ESIC was made beyond the stipulated period prescribed in respective Acts – It was noted that due date for depositing contribution of ESIC & EPF fell on Sunday and gazetted holiday and the assessee had made payment on the very next day – the assessee had no intention not to deposit contribution of ESI & EPF well within time and depositing contribution very next day of holiday proved bona fide off assessee – Whether contributions of ESIC and EPF made by assessee with one day delay was allowable when due date for payment of ESIC and EPF contributions prescribed in respective acts of ESI & PF fell on Sunday or gazetted holiday
In Favour of: The Assessee
Clarification regarding the taxability of income earned by a non-resident investor from off-shore investments in an investment fund routed through an Alternative Investment Fund.
Condonation of delay under clause (b) of sub-section (2) of Section 119 of the Income Tax Act, 1961 for returns of income claiming deduction under Section 80P of the Act for various assessment years from A Y 2018-19 to A Y 2022-23
