Section 56(2)(viib) — Angel Tax on Issue of Shares Above Fair Market Value

Section 56(2)(viib) of the Income Tax Act — popularly called "angel tax" — taxes a closely held company (not listed) when it issues shares to a resident at a price exceeding the "fair market value" (FMV) of those shares. The excess amount (issue price minus FMV) is treated as income of the company and taxed at the applicable corporate rate. Here is the complete guide.

What Is Angel Tax?

• When a closely held company issues shares at a premium to a resident investor at a price higher than the FMV — the excess is taxable in the company's hands as "Income from Other Sources"
• Original intent: Prevent money laundering through inflated share premiums
• Impact: Startup fundraising at valuations based on future projections (above current book value/NAV) faced tax demands
• Finance Act 2023: Extended Section 56(2)(viib) to also cover shares issued to non-residents at above FMV (effective April 1, 2024)

Fair Market Value — Valuation Methods

FMV of shares of a closely held company is determined under Rule 11UA:

• Net Asset Value (NAV) method: FMV = (Book value of assets − Book value of liabilities) / Number of shares
• DCF (Discounted Cash Flow) method: FMV determined by a Merchant Banker's valuation report using projected future cash flows
• Companies can choose either method — startups typically use DCF to justify higher valuations
• Finance Act 2023: Additional valuation methods introduced including comparable company method and probability-weighted expected return method

DPIIT-Recognised Startups — Angel Tax Exemption

• DPIIT-recognised startups are exempt from angel tax under Section 56(2)(viib) — up to total paid-up share capital and share premium of ₹25 crore
• This exemption covers both resident and non-resident investors (from April 2024 notifications)
• To claim: Be DPIIT-recognised and ensure total share capital + premium does not exceed ₹25 crore from all investors combined

Implications for Non-DPIIT Startups

• Companies without DPIIT recognition issuing shares at above NAV to angel investors face income tax demands
• Must obtain a Merchant Banker valuation report using DCF or other prescribed method
• Keep the issue price within the FMV computed — or obtain DPIIT recognition first

Conclusion

Section 56(2)(viib) angel tax affects any closely held company raising funds at above-book-value premiums — making DPIIT recognition and proper Merchant Banker valuation essential for startups. SPOTON provides angel tax advisory, valuation certificate coordination and DPIIT registration for startups across Kerala. Contact us for expert startup compliance services.