The Income Tax Department in India has invited stakeholders to provide their comments on the draft investment valuation rules for angel tax. The draft rules aim to regulate investments made by non-residents and foreign nationals in Indian startups, and will be used to determine the so-called angel tax.
This move comes amidst an ongoing debate surrounding angel tax, which the startup industry has been opposing due to concerns about exacerbating the current funding challenges.
The Central Board of Direct Taxes (CBDT) issued a notification on Friday, inviting feedback on the draft 11UA of Income-tax Rules, 1962.
The CBDT explained that representations were received from various stakeholders expressing concerns about the potential hardships faced by genuine non-resident investors in matters related to share valuation. In response to these concerns, the proposed amendments to the Finance Act, 2023 led to the proposal to amend Rule II UA of the Rules.
The notification specifically addressed the computation of fair market value (FMV) of unquoted equity shares for the purpose of section 56(2)(VIIb) of the Income Tax Act, 1961.
The new rules are expected to be effective from April 1, 2023.
However, the CBDT has not yet provided guidelines for valuing foreign investments in startups that are not recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) for income tax purposes.
Under the existing angel tax norms, only investments made by domestic investors in unlisted companies are taxed above the fair market value, rather than the valuation itself.
The Finance Act, 2023 has expanded the scope of angel tax to include investments above the FMV, regardless of the investor’s domicile.
The industry has raised concerns due to the existence of two separate laws governing fair market value calculations for startup investments. The recent amendments proposed in the finance bill have further intensified these concerns.
While the CBDT has already exempted 21 countries from angel tax, including the US, UK, and Japan, there is contention regarding the exclusion of countries such as Singapore, Mauritius, the Cayman Islands, and the Netherlands from the list.
The Indian government included unlisted startups, except DPIIT-recognized ones, under the angel tax net in this year’s Union Budget. This prompted startups and venture capitalists to seek exemptions for certain overseas investor classes.
Although the CBDT has notified investor classes exempted from angel tax, venture capitalists are planning to approach the Income Tax Department regarding the exclusion of countries like Mauritius and Singapore, given the significant number of VC funds established in those jurisdictions.
