Govt notifies 'Angel Tax' rules for startup investment valuations

The income tax department has notified rules for the Angel Tax valuation for startups, affirming that registered startups will have to pay tax on equity capital raised from foreign investors. The new rules say the valuation of compulsorily convertible preference shares (CCPS) can be calculated based on the "fair market value" of unquoted equity shares.

The amended rules also retain 5 valuation methods suggested in the draft rules -- comparable company multiple, probability-weighted expected return method, option pricing method, milestone analysis method, and replacement cost method.

In May 2023, the CBDT released draft rules for tax levy or 'Angel Tax' on the valuation of funding in startups that are unlisted and unrecognised by bringing in amendments to the Finance Act, 2023.

The amendment provided that if such consideration for the issue of shares exceeds the fair market value of the shares, it will be chargeable to income tax.

Subsequent to the amendment, detailed interactions were held with stakeholders and based on the inputs, Rule 11UA of the Act for valuation of shares was proposed to be modified and notification of entities to which the said provision will not apply was also issued separately.

Under the proposed changes in Rule 11 UA, rather than two prescribed two valuation methods regarding the valuation of shares, discounted cash flow (DCF), and net asset value (NAV), 5 more valuation methods were suggested for non-resident investors.

Further, where any consideration was received by a company for the issue of shares, from any non-resident entity notified by the central government, the price of the equity shares corresponding to such consideration was proposed to be taken as the FMV of the equity shares for resident and non-resident investors.

On similar lines, price matching for resident and non-resident investors will be available with reference to investment by venture capital funds or specified funds.

For excluded entities, the CBDT proposed to notify certain classes of persons being non-resident investors to whom clause (viib) of sub-section (2) of section 56 of the Act will not be applicable, including government and government-related investors such as central banks, sovereign wealth funds, and international or multilateral organisations.

The finance ministry had also notified in May 2023 that non-resident investments into private Indian startups from 21 countries, including advanced economies like the US, the UK, Germany, and France, will not attract angel tax. Key countries like Singapore, the Netherlands, and Mauritius, however, were kept out of the list even though many were one of the biggest contributors of foreign direct investment (FDI) to India in the recent past.