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 FMV will be charged to tax in the hands of the company as income from other sources.

The Central Board of Direct Taxes (‘CBDT’) had issued a notification dated June 14, 2016, providing that investments received by ‘start-ups’ (as specified by the Department of Industrial Policy and Promotion (‘DIPP’)) would not be subject to tax under Section 56(2)(viib) of the IT Act. Further, the DIPP issued a notification dated April 11, 2018, as modified by another notification dated January 16, 2019, specifying the procedure and criteria for start-ups to avail tax benefits (‘DIPP Notification’). The CBDT had also issued a notification dated May 24, 2018, specifying 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 DIPP Notification.

In supersession of the DIPP Notification, the Department for Promotion of Industry and Internal Trade (‘DPIIT’) issued a notification dated February 19, 2019 (‘DPIIT Notification’), introducing new measures for taxation of angel investments. Pursuant to the DPIIT Notification, the CBDT issued a notification dated March 5, 2019 stating that provisions governing angel tax will not be applicable to start-ups that have been recognized by DPIIT in the DPIIT Notification. The salient features of DPIIT Notification are as follows:

i.       An entity will be considered a start-up up to a period of 10 years from the date of incorporation if: (i) the turnover of the entity does not exceed Rs 100 crores (approx. US$ 14.4 million) during any year; (ii) the entity is working towards innovation, development and improvement of products, processes or services or employment generation or wealth creation; and (iii) the entity is not formed as a result of reorganization or restructuring.

ii.      A start-up will be eligible for exemption under Section 56(2)(viib) if it is recognized by DPIIT and fulfills the following conditions:

(a)    The aggregate amount of paid-up share capital and share premium or issuance or proposed issuance thereof does not exceed Rs 25 crores (approx. US$ 3.6 million). This limit of Rs 25 crores (approx. US$ 3.6 million) will exclude investments made by (i) non-residents; (ii) venture capital companies or funds; and (iii) listed companies having net worth of Rs 100 crores (approx. US$ 14.5 million) or turnover of at least Rs 250 crores (approx. US$ 36 million).

(b)     The start-up has not invested in certain specified assets (e.g., immovable properties, loans or advances, shares or securities, capital in other entities, jewelry, drawing, painting, etc.) and does not invest in such assets up to a period of 7 (seven) years from the end of the year in which its shares are issued at a premium. An exception has however been carved out to permit investments carried out by the start-up in the ordinary course of its business.