This document summarizes issues with Section 56(2)(viib) of the Indian Income Tax Act, known as the "Angel Tax". The section taxes capital receipts received by private companies in excess of fair market value. This has led to startups facing high tax burdens due to share premium being taxed. However, share premium is an outcome of valuation and math, not unaccounted funds. Additionally, allowing tax officers to substitute valuation methods creates uncertainty. As a result, early stage investments in India have declined significantly since the introduction of this policy. The recent DIPP circular provides some relief but does not go far enough to resolve the issues.

1. Angel Tax
By
Siddarth M Pai
Founding Partner
3one4 Capital
Section 56(2)(viib) or not (2)(viib)
A presentation on Section 56(2)(viib)
for the Inc42 AMA

2. 2

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4. Section 56(2)(viib)
• Taxes as income any capital receipt in “excess” of the Fair
Market Value of the securities issued by a private company
• Applies to share issued at a premium
• FMV determined as the higher of:
• Value as per DCF or NAV
• As substantiated by the Co to the satisfaction of the tax
officer
• Only applies to Indian investors, not foreign investors – its not
a tax on angels, it’s a tax on Indian investments!
• Exemptions: SEBI registered VC Funds
4

5. Issues with the Section
• High share premium is the outcome of valuation, not an
indication of any “unaccounted funds”
• Valuation methods being substituted during assessment
proceedings

6. The Price of Premium
Why attacking “high” share premium is missing the woods for the trees

7. The Price of Premium
• All Valuation is driven this formula:
Share Issue Price = Enterprise Valuation
No of shares issued
Share Issue Price = Face Value + Share Premium
• A “high” premium can only be
caused by the following:
• Small share base
• High enterprise valuation
• Low face value
A Typical Startup:
• - Enterprise Valuation: Rs 10 Cr - Shares Issued: 10,000 - Face Value: Rs 10
Share Issue Price = Rs 10 Crore
10,000 shares
= Rs 10,000 share “High” Share Premium: Rs 9,900
Face Value: Rs 10

8. Why is share premium being taxed when
it’s the outcome of math, not money
laundering?

9. Valuation Methods: Dealer’s
Choice
Substituting valuation methods is like measuring time in lightyears

10. Value of the Valuation Method
• Method 1: Book Value • Method 2: Discounted Cash Flow
Assets – Liabilities
No. of Shares issued
Image source – parsimo medium - Valuation for startups – 9 methods explained

11. Value of the Valuation Method
• Financials upon Incorporation
• Financials prior to funding:
Round Details:
Pre Money: Rs 9 Cr
Investment: Rs 1 Cr
Post Money: Rs 10Cr
Dilution: 10%
FV: Rs 10/share

12. Value of the Valuation Method
FMV as per Book Value FMV as per DCF
• Time period: 5 years
• Terminal Growth Rate: 5%
• Discount Rate: 25%
Assets – Liabilities
No. of Shares issued
= 75,000 – 2,25,000
10,000
= negative Rs 15/share
Issue Price: Rs 10,000
Face Value: Rs 10
Premium: Rs 9,900

13. Why are valuation methods being
substituted and the difference liable to
tax?

14. Fallout of Section 56(2)(viib)
How this section has affected Indian startups

15. Indian startups have the lowest
valuations worldwide!
Silicon Valley
Europe
Israel
India
Source: Angellist - https://angel.co/valuations

16. Domestic early Investments decline
while other investments rise
Nasscom report – Indian Startup ecosystem Approaching Escape Velocity – Edition 2018

17. No of Early stage rounds is down 28.5%
INVESTMENTS IN START-UPS BY ROUND
Year Seed Series A Series B Series C Series D Series E+
2014 91 145 56 28 11 10
2015 208 257 93 41 12 11
2016 198 186 102 45 20 11
2017 174 154 101 30 21 15
2018 148 137 83 62 24 15
Source: Venture Intelligence

18. No. of unique domestic investors
down 48% since 2015
18
Inc 42 – State of the Indian Startup ecosystem - 2018

19. Circular Reference
Impact of the latest DIPP circular on section 56(2)(viib)

20. New Circular on Section 56(2)(viib)
What the Circular States
• Won’t apply when the cumulative capital
raise is below Rs 10Cr
• Investors with an income > 50l & NW > 2Cr
will have their investments exempt
(accredited Investor)
• Won’t apply to startups who have already
received assessments orders
What it should say:
• Investments upto Rs 10Cr per year will be exempt
as long as the PAN is provided
• Accredited investor:
• Threshold lowered to income >25 OR NW >
1Cr
• Investment to be exempt along the lines of
SEBI reg VC Funds
• Any startup who has received an order can
submit this during appeals

21. Next Steps and Helpful Links

22. Next Steps
• Prepare a response to the assessment order passed & file it within the 30 day
period
• Attach the Startup India DIPP certificate with the above response (if you
haven’t applied, please do at https://www.startupindia.gov.in/
• Attach a copy of the CBDT circular dated 24-12-18 - the no coercive measures
stated implies that the CBDT will not attach the property or the bank accounts
of the Company

23. How iSPIRT Can Help
• Send a copy (redacted and original) of all notices and assessment orders on this issue
to policy@ispirt.in
Resources:
• White paper on Angel Tax - https://pn.ispirt.in/white-paper-on-angel-tax-india/
• · Analysis of the cause of high share premia - https://pn.ispirt.in/white-paper-on-
the-analysis-of-high-share-premium-amongst-startups-in-india/
• · Representation to the government on the matter -
https://www.slideshare.net/ProductNation/angel-tax-presentation-to-dipp-section-
562viib

24. - Honourable Prime Minister Narendra Modi