Currently, under Section 56(2)(viib) of the Income-tax Act, 1961 (ITA), if an Indian private company issues shares to a resident at a premium and the consideration paid for the shares is higher than the fair market value of such shares, then the excess consideration is taxable at 30% as income from other sources in the hands of the Indian company. This tax provision, popularly known as ‘angel tax,’ will cover cases of issue of shares to non-residents with effect from April 1, 2023.
Thus far, Indian companies have raised investments from foreign investors and VC/PE funds at a premium with no tax consequences. Foreign investments are also subject to pricing guidelines under India’s foreign exchange regulations, which mandate that shares should be issued to foreign investors at a price not less than the fair market value to be determined as per any internationally accepted pricing methodology. The FEMA provision is divergent from the ITA provision.
The proposed amendment to include non-residents within the ‘angel tax’ net will result in tax on the difference between the issue price and the ITA fair value in the hands of the company at 30%, which will impact the return on investment. The only exception is if funds are raised from a venture capital company, or a Category I or II Alternative Investment Fund registered with and regulated by the SEBI, or if the company is a “start-up” registered with and so recognised by the Department for Promotion of Industry and Internal Trade.
Press reports suggest that the Finance Ministry is looking into this issue, as also the discrepancy between the FEMA and ITA valuation provisions, and may come up with some clarifications or amendments.