Section 56(2)(viib) of the Income-tax Act, 1961 (‘IT Act’) provides that where a closely held company issues its shares at a price which is more than its fair market value (‘FMV’), the amount received in excess of fair market value will be charged to tax in the hands of the company as income from other sources. The section further prescribes various methods for valuation of FMV of shares of the closely held company. Amongst the various options for valuation of FMV, one of the methods prescribed is determination by a merchant banker or an accountant as per the ‘Discounted Free Cash Flow Method’.

The Central Board of Direct Taxation (‘CBDT’) had, on June 14, 2016, issued a notification providing that investments received by ‘start-ups’ (as specified in the Department of Industrial Policy and Promotion (‘DIPP’)) would not be subject to taxation under Section 56(2)(viib) of the IT Act (‘Angel Tax Exemption’).

The DIPP issued a notification on April 11, 2018 specifying the procedure and criteria for start-ups to avail tax benefits (‘DIPP Notification’). This DIPP Notification had specified three key conditions for availing the Angel Tax Exemption: (i) aggregate amount of paid-up share capital and share premium, after the proposed issue of shares, does not exceed INR 10 crore (approx. US$ 1.5 million); (ii) investor/ proposed investor fulfils the prescribed criteria; and (iii) startup procures a report from a merchant banker, specifying the FMV of shares in accordance with applicable rules.

Pursuant to the DIPP Notification, the CBDT has on May 24, 2018 also notified that the provisions of Section 56(2)(viib) of the IT Act will not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification as per the notification issued by the DIPP Notification. Simultaneously, the CBDT has issued another notification on May 24, 2018 making merchant banker valuation mandatory for the purposes of Section 56(2)(viib) of the IT Act by removing reference to ‘accountant’ in the valuation rules.