Angel Tax: No CBDT Relief For Ongoing Cases
The tax department’s much-awaited notification on angel tax is out and it doesn’t bring good news for startups facing scrutiny.
The angel tax notices stem from Section 56(2)(viib) of the Income Tax Act. Titled Income From Other Sources, the section said any excess consideration received by a company will be treated as its income if it issues shares to a resident at a price which exceeds the fair market value of the shares. Over the last few months, the tax department used this provision to question the valuation at which startups attracted angel funding.
The uproar by the startup community had prompted the Ministry of Commerce to approve a more lenient framework for startups last month. The Department for Promotion of Industry and Internal Trade had specified certain conditions for startups which, if met, would exempt them from the application of Section 56(2)(viib). And businesses were keenly awaiting the stance of the tax department on the issue.
The department has now stated that Section 56(2)(viib) will not apply to amounts received by a company for issue of shares that exceed face value of such shares. This relief will be available to startups that fulfill the eligibility criteria laid down by the DPIIT.
For instance, the DPIIT had expanded the definition of startups to say—a company will be considered a startup for 10 years from the date of incorporation instead of seven, and the maximum turnover to be called a startup would be Rs 100 crore as opposed to Rs 25 crore. The DPIIT criteria barring startups from investing in certain assets will also need to be met to ward-off action from the tax department. A declaration stating that the startup meets all the eligibility criteria will need to be filed with the DPIIT.
But the benefit of the relief offered by the tax department will be limited since its notification will apply from Feb. 19 onwards. The CBDT notification said:
This notification shall be deemed to have come into force retrospectively from Feb. 19, 2019.
This notification doesn’t give a blanket exemption for startups with orders like us, Sreejith Moolayil, co-founder of health food startup True Elements, said. Moolayil’s company received two notices on the share premium amount for angel funding raised in January and April 2015. But what gives hope is the retrospective line in the CBDT notification. “We can use this at the appeal stage and hopefully get an exemption,” he said.
A blanket exemption could have saved time and effort of both the tax department and businesses who are facing scrutiny.Sreejith Moolayil, Co-founder, True Elements
Any assessment process—show cause notices or assessment orders—prior to Feb. 19 won’t get any benefit and this notification may only have a persuasive value, Maulik Doshi, partner at SKP Group, said. Even cases where the department hasn’t initiated any action, but shares were issued prior to this date won’t get any relief, he said.
Any startup that allotted shares to its angel investor prior to Feb. 19 and this case hasn’t come up for assessment won’t benefit from the CBDT notification either. So, this is more of a prospective relief which is surprising considering the DPIIT notification came as a result of representations made by startups that had got Section 56(2)(viib) notices.Maulik Doshi, Partner, SKP Group
Subramaniam Krishnan, private equity tax partner at EY India, agreed that while the notification doesn’t grant a blanket exemption, some startups can avail the benefit by getting DPIIT certification at the earliest.
He said in cases where neither tax demands have been raised nor scrutiny assessment notices issued for past share issuances, startups should make declarations as envisaged under the DPIIT notification, Krishnan said.
It is strongly advisable for startups to make declarations as envisaged in the DPIIT notification and fulfill the conditions to pre-empt any litigation on ‘angel tax’ issue. If the conditions of the DPIIT notification are not fulfilled, the startup will need to be prepared to defend the share valuation on merits.Subramaniam Krishnan, Partner, EY India
Even cases where only show cause notices have been issued and no tax demand has been raised can get relief by quickly moving to get the DPIIT certification, he said.
The intent of the tax department is clear—it doesn’t want to grant any retrospective relief and so, ongoing cases will need to be taken to their logical end through the assessment stage followed by appeal process if necessary, said Ameet Patel, partner, Manohar Chowdhry & Associates.