The Centre on Tuesday notified rules pertaining to valuation of equity and compulsorily convertible preferable shares issued by startups to resident and non-resident investors based on changes made in the Finance Act 2023.

Angel tax (basically income tax) at the rate of 30.6 per cent will be levied when an unlisted company issues shares to an investor at a price higher than its fair market value (FMV). The new rules will be effective from September 25.

The amended rules also retain the five new valuation methods proposed in the draft rules for consideration received from the non-residents

Comparable Company Multiple Method

Probability Weighted Expected Return Method

Option Pricing Method

Milestone Analysis Method

Replacement Cost Method.

The CBDT had in May come out with draft rules on valuation of funding in unlisted and unrecognised startups for levying income tax, commonly termed as 'Angel Tax' and had invited public comments on it. The amended rules are aimed at bridging the gap between the rules outlined in FEMA and the Income Tax.

So far, only investments by domestic investors or residents in closely held companies or unlisted firms were taxed over and above the fair market value. This was commonly referred to as an angel tax.

The Finance Act, 2023 has said that such investments over and above the FMV will be taxed irrespective of whether the investor is a resident or non-resident. Post the amendments in the Finance Act, concerns have been raised over the methodology of calculation of fair market value under two different laws.

What is Angel Tax?

For starters, when a privately-held company or a start-up raises money by issuing its equity, the amount raised is subject to income tax. Earlier, the tax applied only to money raised from the Indian investors but the Union Budget 2023 expanded its ambit to include foreign investors as well.

For instance, a startup raises Rs 5000 by issuing 100 shares at Rs 50 each to an investor. Now let’s assume that the fair market value of these shares is Rs 10 each. The tax will be levied based on the difference, i.e., Rs 40 per share. The lesser the difference, the lower the tax. That is where determining the proper fair market value will be critical.

Experts react on new angel tax rules

Welcoming the new rules, experts expect these to ensure that start-ups can continue raising money efficiently from foreign angel and venture capital investors while also cautioning on the impact of ‘funding winter’ on old valuations.

"A very welcome change. It is very much accepted that the valuation that traditionally applies to an organisation, which is purely on the basis of book value etc, cannot apply for startup – there are different considerations which apply and what has now been provided," Dinesh Kanabar of Dhruva Advisors told CNBC-TV18.

Girish Vanvari of Transaction Square cautioned that there is a need to see angel tax calculations based on old valuations.

"What is keeping people bothered and worried is the past. A lot of funding happened over the last three years, at different points in time and at higher valuations. Now, with the funding winter, the valuation has corrected, and it is on a downward trend. In that case, how will the tax office look at the old valuations done and the old issues relating to angel tax in light of the funding winter? That's one thing that is a worry, irrespective of these rules.”