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28 Jun, 2025
By Online Legal India
Published On 27 Jun 2025
Category Taxation
Angel taxation refers to a tax provision that targets unlisted companies issuing shares at a premium above fair market value. Introduced as a regulatory safeguard, it aims to prevent the use of inflated valuations to channel unaccounted funds into startups. Over time, the provision has sparked intense debate due to its wide applicability, impact on genuine investments, and evolving compliance requirements. In this article, you will learn about angel taxation, its exemption, its impact and more.
Angel taxation was a regulatory provision under Section 56(2)(vii b) of the Income Tax Act that targeted unlisted companies issuing shares at a premium exceeding their fair market value. The differential amount was taxed as income, treating it as an unexplained cash credit rather than a legitimate capital infusion. Intended as an anti-abuse measure, it aimed to curb money laundering through inflated valuations but often penalised early-stage startups relying on future potential rather than tangible assets for valuation.
Angel taxation is applied to unlisted, closely held companies, primarily startups when they receive equity capital from a resident investor at a price exceeding the fair market value (FMV) of the shares.
The following conditions triggered liability:
Initially, non-resident investors were excluded from the scope of the angel tax. However, after the Finance Act 2023, the provision was extended to non-resident investors as well, significantly widening its applicability. Certain categories of foreign investors were later notified as exempt, subject to government approval and regulatory criteria.
The exemptions available under angel taxation are listed below:
The startup must obtain recognition from the Department for Promotion of Industry and Internal Trade (DPIIT). This recognition confirms the company as an eligible startup under government-defined parameters.
The exemption applies only to private limited companies and limited liability partnership (LLPs). Other business forms do not qualify under the exemption framework.
The company must not complete more than 10 years from the date of its incorporation. The exemption lapses once the entity crosses this age limit.
The startup must maintain an annual turnover below ?100 crore in every financial year since incorporation. Even a single breach of this cap disqualifies the startup.
The company must not invest in assets unrelated to core business operations. This includes immovable property not used in business, loans, capital contributions, shares, and securities. Such transactions lead to automatic disqualification.
The share issue price must align with accepted valuation methods under the Income Tax Rules. A certified valuation report helps validate the pricing.
The exemption applies only when investments come from resident individuals, registered Category I Alternative Investment Funds, or notified foreign investors. Investments from unqualified sources fall under angel tax liability.
Although angel taxation stands abolished from FY 2024–25, startups that raised capital before this period must ensure compliance with earlier provisions to avoid liability. The following steps outline how to safeguard such transactions:
Determine the share price using either the Discounted Cash Flow (DCF) method or the Net Asset Value (NAV) method, as prescribed under the Income Tax Rules. Obtain a valuation report from a SEBI-registered merchant banker or a chartered accountant to validate the pricing.
Record each investor’s PAN, permanent address, and funding source. Preserve related documents such as investment agreements, fund transfer receipts, and KYC records. These serve as proof of legitimate capital infusion and support during tax assessments.
For capital received before April 1, 2025, secure DPIIT recognition through the Startup India platform. Ensure the startup meets the required conditions, including incorporation within ten years and annual turnover not exceeding ?100 crore.
Avoid deploying funds into non-permitted assets. These include immovable property not used for business, unsecured loans, capital contributions to other entities, or financial instruments like shares and bonds. Any such transaction nullifies exemption eligibility.
Raise capital only from investors recognised under government guidelines. Eligible categories include Category I Alternative Investment Funds, SEBI-registered venture capital funds, and foreign investors notified as exempt.
Prepare and update a detailed cap table showing the number of shares issued, the issue price, the premium collected, and the valuation methodology used. This structure must match the information declared in the startup's filings and financial statements.
If the startup receives a notice under the Income Tax Act, submit a complete response within the stipulated timeline. The reply must include the valuation report, investor records, DPIIT certificate (if applicable), and financial statements for the relevant period.
The recent updates and policy changes regarding angel taxation are as follows:
The Finance Act, of 2023 amends Section 56(2)(vii b) to include non-resident investors within the scope of angel tax. Previously, the provision applied only to capital received from Indian residents. From April 1, 2023, startups must comply with valuation regulations for all equity investments, whether domestic or foreign, if the issue price exceeds the fair market value.
CBDT Notification No. 81/2023, effective September 25, 2023, expands share valuation options for startups. For resident investors, only NAV and DCF methods apply. For non-resident investors, startups may also use Comparable Company Multiples, Probability-Weighted Return, Option Pricing, Milestone Analysis, and Replacement Cost. This update aligns valuation practices with global norms and eases compliance in cross-border funding.
The same notification introduces a 10% safe harbour margin. If the share issue price does not exceed 10% above the determined fair market value, the transaction falls outside the scope of angel tax. This adjustment creates flexibility for startups to raise funds without facing penal tax consequences over minor valuation gaps.
The Union Budget 2024 announces the full abolition of angel tax, effective April 1, 2025. Startups no longer face tax on share premiums, irrespective of investor type. DPIIT recognition is no longer required for exemption. This reform simplifies compliance and strengthens India’s investment ecosystem.
The impact of angel taxation is as follows:
Angel taxation limits startup funding at early stages. Investors avoid high-valuation deals due to tax risks. This reduces capital inflow and stalls the launch or growth of new ventures.
The fear of tax scrutiny pushes many investors away. Domestic and foreign investors prefer safer assets instead of startups, which carry regulatory exposure and uncertain valuation outcomes.
Startups lower their valuations to avoid tax implications. This results in underpricing equity, which creates inconsistencies in future rounds and erodes founder ownership unfairly.
The law requires startups to produce formal valuation reports, maintain detailed investor records, and respond to tax notices. These obligations increase legal costs and stretch limited internal resources.
Tax authorities deduct funds directly from bank accounts in certain cases. This blocks access to essential working capital and disrupts daily operations, especially for startups with lean cash flow.
Startups rely on funding to build teams. When capital is restricted, hiring slows down. This affects talent acquisition, delays expansion plans, and reduces employment generation.
Extending angel tax to non-resident investors triggers global concern. Foreign funds face unclear rules and prefer markets with transparent valuation norms, leading to a dip in foreign direct investment.
Sectors like artificial intelligence, biotechnology, and clean energy depend on early speculative capital. Angel taxation restricts this funding, which limits research, product development, and long-term scalability.
Conclusion
To sum up, understanding the impact and evolution of angel taxation is essential for grasping the challenges India's startup ecosystem has faced in its early growth phase. The provision affected access to capital influenced valuation strategies, and created regulatory uncertainty across funding stages. Its abolition marks a decisive move towards a more enabling and investor-friendly environment.
While the reform simplifies future transactions, past investments still demand legal precision. Online Legal India offers end-to-end assistance in valuation compliance, exemption support, and tax representation, ensuring startups navigate this transition with full legal confidence and operational clarity.
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