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  • Venkata Kartheek Vegesana

Analysing the Impact of the Widening of Angel Tax on Indian Economy and Start-up Ecosystem

[Kartheek is a student at NALSAR University of Law.]

On 1 February 2023, the Finance Minister of India introduced the budget for the Financial Year 2023-24, which outlined various governmental policies and financial allocations for different sectors. The budget also included the Finance Bill 2023, which proposed a range of changes with consequential effects on the Indian economy and its financial health. These changes included numerous direct and indirect tax proposals and amendments.

This article aims to primarily analyse the impact of the widened Section 56(2)(viib) of the Income Tax Act 1961 (IT Act). This tax, commonly referred to as angel tax, is levied on a certain type of investors and has created hurdles in the start-up ecosystem. The tax attempts to tax share premium by non-residents and also determines the cost of the shares (fair market value). Additionally, there is a form of dual regulation, as foreign investment regulations, including the Foreign Exchange and Management Act 1999 (FEMA), usually guide the valuation of shares issued to non-residents.

Impact of Angel Tax

The Parliament amended Section 56 of the IT Act through Clause 32 of the Finance Bill 2023. Section 56(2)(viib) aims to regulate share premium of a company by taxing the capital generated by the company through the sale of shares at a price higher than the market price (fair market value). To better understand this section, we need to examine its objective. This tax is usually referred to ‘angel tax’.

Objective of Section 56(2)(viib)

The intended purpose of Section 56(2)(viib) is to deter the generation and use of unaccounted money by a company through subscription of shares of a closely held company at a value which is higher than the fair market value (determined through Section 11UA). To lay down this section in bare terms, its purpose is to prevent the circulation of unaccounted money as share premium. This was introduced in 2012, after a trend of events where the assessing body observed companies masking unaccounted money as share premium.

Existing Provision

Currently, this form of tax on share premium is only applicable on residents. The income generated from accumulating such share premiums is to be considered as income from other sources under Section 56, and is to be assessed and taxed accordingly.


The amendment removes the residential qualification for the applicability of this provision. The expectation of a range of investors and companies was that the government would completely get rid of this form of tax, as it was posing unrequired burden on share premiums which, in the traditional form of understanding, was something which the investor would pay over and above the value of share, based on the company’s performance and qualities. The government completely turned that expectation on its head and expanded the application of such tax to non-residents as well.

Dual Regulation

The problem with the amendment is that it leads to a situation of dual regulation, as there are already regulations in place under the FEMA for the valuation of shares issued to non-residents. These regulations include Regulations 6 and 8 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations 2017, which provide for the valuation of shares as per internationally accepted methodologies. These regulations also establish the fair market value (in India) as the floor price for any sale of shares to non-residents.

The taxpayers face an inherent challenge as they have to satisfy both sets of requirements. This is due to the fact that the valuation system is not aligned: the value of shares is determined by the fair market value (as discussed under Section 11UA) in India, whereas internationally accepted methodologies for foreign investors accord a certain value to the shares (for which the fair market value is the floor price).

Critique of the Amendment

This amendment effectively makes angel tax mandatory on all foreign investments. Since the fair market value serves as the floor price, any share price resulting from negotiations between the buyer and the seller must exceed this floor price. This move essentially means that Parliament is imposing angel tax on all foreign angel investments.

Returning to the objective of this section, we can see that its earlier stated purpose was to prevent the circulation of unaccounted money through share premiums. However, it also serves an unstated objective of regulating and monitoring foreign direct investment into the country.

Another critique of the amendment relates to the nature of share premium. Traditionally, share premium is not considered income but rather the value that shareholders pay over the share price based on the potential of the company. Taxing share premium on foreign direct investment could be seen as a hindrance to the start-up community in raising capital from foreign investors. The amendment deprives companies of good market-driven economic valuation, negatively impacting price negotiations.

The overarching and cascading effect of this amendment would be a reduction in foreign investments in start-ups. It may also force start-ups to place holding structures overseas and shift the place of effective management abroad to avoid pressure from potential investors regarding the impact of this amendment.

A potential immediate consequence could be start-ups pushing to get investment deals done before 1 April 2023 (the date this amendment would become applicable) to avoid paying taxes on share premiums. Exemptions to this tax have only been given to recognized start-ups.


The author concludes that this form of angel tax moves India away from the international standards of business freedom that we are trying to attain. If India is to become a more attractive investment destination, we should enact laws that are more investor-friendly, especially for international investors. The angel tax prevents money from coming into the hands of Indian companies, as the excess income to be taxed forms part of income from other sources under Section 56 of the IT Act. The dual regulation discussed in this article needs to be addressed by the Parliament to reduce the compliance requirements for international investors.


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