Want to learn more about angel tax? We’ve got you covered! Watch the latest edition of JSA Live, where our Partners – Lalit Kumar and Kumarmanglam Vijay analyse the amendments made to include investments from non-residents within the purview of what is popularly known as Angel Tax.
Hello everyone, I am Lalit Kumar, Corporate & M&A Partner. I have with me Kumarmanglam Vijay. Kumar is our Partner & Head of Practice – Direct Tax.
Today, Kumar and I will discuss the recent amendments made to include investments from non-residents within the purview of what is popularly known as Angel Tax. As you may know, Angel Tax is not a new provision in income tax law. It has been in existence for the last 11 years. However, it has drawn much attention after the 2023 Union Budget that proposed amendments to it.
For viewer’s understanding, Angel Tax is charged under the head of ‘Income from Other Sources’ upon the issuance of shares by a closely held Indian company on the amount of consideration received by it which is in excess of the ‘fair market value’ of shares issued. Previously, this tax was charged only on the issuance of shares to persons who are residents in India. With effect from April 1, 2023, the angel tax net has been widened to include the issuance of shares to non-residents as well. As can be anyone’s guess, this will have a significant impact on inbound investments in India, which is what we are going to discuss.
Kumar, before discussing the changes, if could please explain what was the position until this amendment? and how was the fair market value of shares determined?
Thank you Lalit. As already mentioned by you, it applied only to closely held companies receiving investments from resident investors. There were few exceptions like in the case of investments received by a registered start-up on fulfilment of certain conditions and investments received from the venture capital funds, Category I and II AIF’s and Gift-City Funds.
As far as determination of fair market value is concerned, companies could get valuation as per adjusted Net Asset Value method, or Discounted Free Cash Flow method and opt for the higher of the two valuations as fair market value. DCF valuation report has to be obtained from a Merchant Banker.
Companies could also substantiate the value of the shares before the Income Tax Authorities, based on the value of its assets, including intangible assets (such as goodwill, know-how, patents, licenses, franchise rights, etc.
Thank you Kumar. This brings me to my next question.
Could you please tell us what will be the position going forward?
The major change is that now the angel tax provisions will apply to even investments received from non-resident investors. Having said that, it is interesting to note that the exemptions and proposed rules for valuation are not the same for domestic and foreign investors.
As far as exemptions from the applicability of angel tax are concerned, the government has provided relaxation to :
- Eligible start-ups which receive investments from non-resident investors. Until now, it was limited only to investments received from resident investors.
- Three classes of foreign investors are exempted:
- Government related investors including central banks, sovereign wealth funds, international or multilateral organizations;
- Banks or entities in the insurance business;
- Four categories of entities that are residents of specified countries, these are
- SEBI Registered category-I FPIs;
- Certain categories of Endowment and Pension funds;
- Broad-based pooled funds with 50 or more investor which are not hedge fund or a fund which employs diverse or complex trading strategies.
The specified countries include Australia, Germany, Japan, Korea, UK, and USA amongst others. Mauritius, Singapore and the Netherlands from where substantial foreign investments are received in India have been excluded.
Foreign investors are also allowed to value shares using Comparable Company Multiple Method; Probability Weighted Expected Return Method; Options Pricing Method, Milestone Analysis Method and Replacement Cost Methods. Safe harbor provisions permit subscription price of shares within a range of 10% of the fair market value.
A concept of price matching has been introduced. Where investment is received from an AIF, the subscription price is considered as the fair market value for the other investors as well. A similar price-matching benefit is proposed for investments received from the exempted class of foreign investors as mentioned earlier. This price-matching benefit will be provided only to the extent of consideration that will be received from these types of investors.
It seems an elaborate valuation mechanism has been provided allowing flexibility in choosing a valuation method. Regarding its applicability, is it correct to say that all these new changes are applicable only to unlisted equity shares?
Yes Lalit. These new valuation rules are applicable only in respect unlisted equity shares. For preference shares, the existing provisions would continue. The current valuation norm considers the price of preference shares to be an amount that it would fetch if sold in the open market on the valuation date as its fair market value.
Now coming to the challenges posed by this new rule, since this is a new proposal I am sure there will be many ambiguities which need further consideration? Could you please share your thoughts on this?
Yes, you are right, there are many open issues that are not fully addressed. To take a few examples –
- the safe harbor and price matching benefit are not made available for preference shares which as we all know are the preferred instruments for foreign investors like PE and VC funds.
- I think that 10% safe harbor may not be sufficient given certain commercial and legal rights which are usually sought by such investors, such as anti-dilution, adjustment of conversion ratio based any corporate action by investee company. Ideally, this could have a higher limit, say about 20-25%.
- Investors from popular jurisdictions like the Netherlands, Singapore, Mauritius, and Cyprus are not exempted.
- Specific condition of having more than 50 investors for broad-based funds could make it difficult for the feeder funds used for investments in India
- There are few other interpretational issues in the language of proposed rules which we hope would get addressed in the final rules.
Thank you Kumar for your valuable insights. Undoubtedly, this is a big development and as we go along, we can only hope more clarity will emerge to understand this tax better. Definitely this is a space to watch out for.