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  • Aliza Khatoon

The Angel Tax Demonic-Emergence and the Silver Lining of CBDT Proposal

[Aliza is a student at Rajiv Gandhi National University of Law.]

In 2012, the legislature amended the Income-tax Act 1961 (ITA 1961) and inserted Section 56(2)(viib) into the ITA 1961, now prominently known as the ‘angel tax’. The legislative intent behind the enactment was to strike at the increasing tainted and under-the-table transactions that take place through investment in shell companies, as well as to regulate investment-related tax evasion. The provisions of angel tax provided that where a company (not being a company in which the public is substantially interested) receives from any person being a resident, any consideration for the issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be deemed to be income of that company and chargeable under ITA 1961. The method of calculating fair market value (FMV) was prescribed under Section 11UA ITA1961. FMV is calculated by estimating a price that unquoted shares and securities would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. The startup ventures became subject to angel tax applicability upon satisfying the conditions mentioned in Section 56(2)(viib). Subsequently, startups receiving excess investment above the FMV became taxable. However, to foster and sustain Indian startups, the government introduced exemptions from angel tax. For instance, the government came up with the Department for Promotion of Industry and Internal Trade exemption notification of 2019 that provided certain start-ups with angel tax exemption.

Conversely, departing from the startup-centric approach adopted by the government the Finance Act 2023 enlarged the scope of angel tax applicability to include ‘non-resident’ investors contrary to the previous ‘resident’ only applicability. This amendment (Finance Act 2023 Amendment) caused uproar in the Indian startup ecosystem. The article analyses this amendment pertaining to angel tax provisions and substantiates its implications for foreign investors. Additionally, it highlights the simultaneous compliance conundrum between the Foreign Exchange Management Act 1999 (FEMA) regulations and the angel tax. Thereafter, it examines the Central Board of Direct Taxes (CBDT) notification concerning angel tax and its affirmative outcomes followed by proposals to mitigate investors’ apprehension arising out of angel tax applicability.

Angel Tax Through Foreign Investor’s Lens

The Finance Act 2023 amended Section 56(2)(viib), extending tax applicability over excess consideration received above FMV by a company from ‘non-resident persons’. The dispensation of distinction between ‘resident’ and ‘non-resident’ investors is critical to foreign investors’ interest. Since it circumscribes the scope of investment for the recipient company by levying taxes upon receiving excess consideration, this provision damages the ease of doing business and affects the prospects of fundraising through foreign channels. 


Angel tax runs antithetical to India’s international standpoint. The Indian startup ecosystem thrives upon foreign investment. In 2022, Indian startups raised $26.8 billion, of which $26 billion came from foreign investors. Further, India has spearheaded initiatives such as Startup20, focused on the spirit of collaborative entrepreneurship. The Startup20 policy paper recommends building a supportive startup ecosystem, providing reasonable tax incentives, and creating knowledge channels. These recommendations complement India’s SDGs goals 8 and 9 of promoting economic growth and innovation.

Against this backdrop of India establishing a collaborative startup ecosystem, the angel tax unfolds as a regressive taxation rule that adversely affects foreign investors’ commercial consideration regarding anti-dilution rights, transfer pricing (TP) provisions, and compliance costs. These factors are crucial determinants for foreign investors when deciding on investment, thereby expanding the scope of angel tax risks to constraint foreign investment. This analysis is substantiated as follows.

First, with regard to anti-dilution rights, the investors subscribe to shares higher than the FMV price and, in exchange, they reserve anti-dilution rights which protect investors in case of a down round or exit. However, angel tax applicability over shares issued at a higher price than FMV is taxable for investee companies. Therefore, the anti-dilution rights negotiation results in a tussle between investor’s protection of their rights and the investee company’s tax liability.    

Second, concerning transfer pricing, the angel tax regime creates a possibility wherein the international transaction may attract scrutiny under TP, contrary to the erstwhile exemption. It overturns the Vodafone India Services Private Limited (Bombay High Court) judgment that upheld that the issue of shares by an Indian company to non-resident investors does not constitute income and international transactions were exempted from transfer pricing regulations. However, under angel tax, if the foreign investor and the investee company qualify as associated entities under Section 92A of the ITA 1961 and the exceeding issue of shares made is taxable under Section 56(2)(viib) that would qualify such international transaction as income and consequently requires it to comply with TP provisions.

Lastly, the enactment may result in increasing compliance litigation by subjecting transactions to additional compliances such as TDS deduction, e-filing, etc. Further, tax authorities are permitted to securitize the valuation report and determine a fresh valuation. Such instances prolong disputes and disrupt business operations. These concerns highlight the detrimental impact of expanding the angel tax regime on investment through the lens of foreign investors. 

FEMA and Angel Tax Conundrum

The simultaneous compliance with the inconsistent FEMA and angel tax provisions creates a compliance conundrum for non-resident investors. The FEMA regulations mandate that shares issued to non-residents shall be valued more or equal to FMV. The FMV calculation under FEMA allows for any internationally accepted pricing methodology. Conversely, angel tax stipulated that excess of the consideration received for shares issued above FMV was taxable for the investee company. The angel tax FMV calculation was earlier restricted to accept 2 prescribed methods. These conditions raised inflexibility for investors and unlisted companies, to issue shares only at FMV.

CBDT Notification: A Silver Lining

In September 2023, CBDT issued a notification amending angel tax to rectify stakeholders’ apprehension. CBDT resolves the FEMA and angel tax compliance conundrum by increasing the FMV valuation methodology to 5 for the non-residents which ascertains consistent valuation methodology for angel tax FMV and FEMA FMV. Further, it incorporates the ‘excluded entities’ provision which exempted angel tax applications to certain entities from 21 notified jurisdictions. Lastly, it introduced a 10% safe harbour provision that accepts variance in the valuation of shares up to 10% from FMV. These affirmative measures by CBDT are appreciable, yet inadequate to safeguard investors’ anti-dilution and transfer pricing compliance concerns. Therefore, to address foreign investor’s concerns in addition to the CBDT notification a two-pronged approach is recommended to be adopted – first at an institutional level and second at the investment negotiation level. 

Government measures to create institutional safeguards include construing guidelines that demystify the interplay between the angel tax and the TP regulation. The expansion of angel tax applicability will likely overburden TP litigation in India estimated to account for more than half of the world’s TP disputes. Clearly drafted guidelines would thereby simplify compliance. Next, enhancing safe harbour from 10% to 20-25% grants investors the flexibility to invest above FMV while exempting investee companies from avoiding taxability, thereby sustaining investors’ anti-dilution rights.

The investors at the negotiation stage could first resort to contractual enforcement of anti-dilution rights by investing through debt instruments such as non-convertible debentures and optionally convertible debentures. The angel tax applies to excess premium over issuance of shares and strict interpretation of the provision exempts debt instruments from taxability. Hence, the ceiling limit of FMV prescribed by angel tax is inapplicable to them. 

Further, opting price matching mechanism from a specified funds route wherein foreign residents can take the price of shares corresponding to specified funds consideration as FMV subsequently exempting angel tax. Similarly, investing through GIFT city AIFs is exempted from angel tax applicability. 

Hence, a silver lining emerges with the CBDT notification coupled with additional government measures for compliance reliefs and well-defined guidelines could mitigate investors’ apprehension. Moreover, investors and investee companies exploring different exempted structures and debt instruments for investment would further serve to safeguard investors’ interests. 


While the Finance Act Amendment 2023 intended to curb tainted transactions from foreign channels by extending angel tax to non-resident investors, it has attracted criticism for its adverse impact on the startup ecosystem. The amendment increases tax liability upon the startup and severely affects their dependency on seed funding during their initial rounds.

With respect to investors, it negatively impacts their anti-dilution rights, expands TP provisions, and increases compliance costs which consequently reflects prejudicial to attract foreign investment in India. However, it becomes pertinent to note that the government has recognized the raised challenges. In view of such implications, the CBDT through its notification aims to ameliorate the concerns, such as the simultaneous compliance of FEMA and angel tax provisions, introducing the safe harbour for investment, etc. Despite these efforts, the CBDT notification does not effectively resolve the foreign investors’ apprehension concerning their anti-dilution rights and compliance costs. Therefore, it becomes imperative to undertake measures both at institutional and investment negotiation stages to protect investors’ interests and safeguard investments in Indian startups.


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