Angel Tax on Non-resident Investors under ITA: An Obstacle to FDI in India?

[By Parth Bindal and Somasundararajan B]

The authors are students of School of Law, UPES.



In this piece, the authors critically argue that the decision of the government of India to bring “non-resident investors” under the purview of the Angel Tax regime after the removal of the wording “person being a resident” from section 56(2) (vii b) of the Income Tax Act, 1961(hereinafter referred to as said section), post the amendment made under the said section through passing of Finance Act, 2023 by Parliament,(Act 2023) will hurt the private business entities raising capital through foreign investors and will also be a contradiction to governments primary intention of making India an Investor friendly global destination.


The Indian law makers introduced the Angel Tax Regime in India through the amendment made in the said section, through the passing of the Finance Act, 2012. In the memo of the Finance Bill, 2012, it was observed that the angel tax regime is required to put a “check & control” mechanism on the detrimental practice of misrepresenting unaccounted funds and black money as an investment in a private company’s share capital, which must be avoided.   The regime governing the angel-tax aspect before the passing of the Finance Act, of 2023, had two-layer domain structure which  required private companies to disclose the source of the investment in possession of the investor (section 68 of ITA) & ensure that compliance with Fair Market Value (FMV) where the investment at a premium is obtained from resident shareholders under the said section.

Interpretation of the wording, “person being a resident” under the said section, explains that it is only applicable to resident investors and the legislature intended to keep non-resident investors outside the purview of tax compliances before the Act of 2023. The exclusion of non-resident investors is justifiable since such transactions are governed and regulated by the FEMA and rules made thereunder i.e., Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“FDI Norms”). FDI Norms mandate non-residents engaging in Foreign Direct Investment (FDI) transaction with private entities are bound by the pricing standards, which requires companies to issue equity securities to a non-resident at a price not lower than the fair valuation of the respective securities (as determined by an internationally recognized pricing technique) & subsequently verified by a chartered accountant or through a SEBI registered merchant banker.

Another issue is the difference of opinion between the taxpayer and the income tax authority over what the FMV should be. This is because as per clause (a) of the explanation to the said section, FMV shall be the greater of the following values: (i) determined using an established method; & (ii) as may be demonstrated to the satisfactory satisfaction of the income tax authorities by the company. The “prescribed method” under Rule 11UA of the Income-tax Rules, 1962 (“hereinafter referred to as the ITR”) enables a taxpayer to value a company’s unquoted shares using either the value of net assets per share or the discounted cash flow (“DCF”) approach derived by a merchant banker. Even though it is a “prescribed method” in ITR but under the said section, and certain Income Tax Appellate Tribunal (ITAT) decisions show that the tax authorities went beyond to object to the DCF method’s application.

Furthermore, the majority of startups raise capital based on their funding requirements & a financier’s view of their expansion possibility, the valuations they receive are probably going higher than those obtained using the net value of assets or discounted cash flow methods. The autonomy provided to tax officials under the said section to decline such an assessment are a source of dispute, leading to a slew of litigation. To mitigate the impact of such autonomy; the Finance Act of 2012 included an exemption for investments made by venture capital companies or venture capital funds (“VCFs”). The Finance Act of 2019 extended the aforementioned exemption to considerations paid by Category I & Category II Alternative Investment Funds (“AIFs”).

Following that, the government notified certain groups of people that would be considered exempt from the provisions of the said section. For example, the Ministry of Commerce and Industry notified enterprises who would be eligible under the umbrella of “start-up” as exempt. Yet, other start-ups & smaller private companies do not seek capital solely through VCFs & AIFs. As a result, the subject of valuation disagreements among investee companies & tax authorities stays contentious, & the measure has been dubbed an “angel tax.” Another important aspect to note is that these lacunae were attempted to be rectified with subsequent amendments in the said section.

But the latest development of bringing non-resident investors into the ambit of the angel tax regime may result as counter-productive in terms of the government’s efforts in making India a global destination for investors and puts a break in its efforts to make India an investor-friendly state with additional compliance for them under FDI Norms. This move will majorly affect fundraising by start-ups that are not registered with DPIIT. According to a report by market research platform Tracxn, financing for Indian startups fell 75% to $2.8 billion in the initial quarterly period of the year 2023, as opposed to the identical time period the previous year (YoY), where it came at $11.9 billion. According to the ‘Tracxn Geo Quarterly Report: India Tech – Q1 2023′ report, the decrease in funding for startups is likely caused by increasing interest rates & inflation, which has an important effect on funding.


The current amendment to the discussed said section through Finance Act, 2023 will pose a great challenge to the private companies and start-ups which are not registered with DPIIT. Surprisingly the said section also contains deemed income provision, which conveys that if the buyer of particular kinds of property (including securities) gets such property for an amount less than its FMV calculated in the prescribed way, the difference of the FMV over the price paid is subject to tax in the acquiring company’s hands.

The tax authorities believe that the deemed income provision also applies to shares acquired via a primary issuance. So, from a tax standpoint, the share issue price has to comply with both of these provisions. Besides, either the Private companies issuing shares or the investors subscribing to such shares may face tax consequences. Although it’s already applicable for shares given to resident investors, comparable factors will be applied to the capital raised from non-resident investors in the future. Due to all such moves, the non-resident investors will have to face a two-fold compliances burden, one under criteria of issuance not above the FMV and Second, to comply with the valuation necessities already enforceable under FEMA law, which in turn puts a big question mark on government standpoint of “Ease of Doing Business in India”.

On one hand, non-residents must be issued shares on an FMV basis, according to FEMA regulations. As a result, while the angel’s tax provision specifies a ceiling value (beyond which the issuing PLC faces adverse tax consequences), FEMA regulations specify a floor price. To this point, the angel tax provision as well as the FEMA pricing specifications seem to be contradictory. To avoid repercussions according to the angel tax provision or FEMA regulations, the PLC appears to have to issue shares precisely at the FMV, which would be extremely stringent & may not be economically viable.

Another issue is concerning the angel tax provision’s applicability to the conversion deals remains valid, there could be valuation-related conflicts with the angel tax provision alongside FEMA regulations. For example, under FEMA regulations, converting instruments can’t be converted at an amount lower than a non-resident investor’s initial subscription price. Even though the enterprise’s valuation has dropped, that’s still the case. In this case, if the angel tax provision is in effect at the point of the equity security conversion, the fair market value of the private limited companies’ (PLC) shares at the moment of the conversion could be below the amount for which the convertible instruments/security were released.

To substantiate on the same note, where the fair market value drive determined by DCF is a foreign exchange compliance standard in private equity & venture capital transactions, investments take place at an amount larger than the FMV. It is due to a misalignment between how the owner views the valuation of the business & the way investors view its worth. To close the gap, investors frequently invest at an amount greater than the FMV but with balancing advantages such as anti-dilution rights, liquidation preferences, and so on. As a result, the change in the rule is likely to cause problems in the bargaining of such rights when such Indian companies raise funds. This will render investing with private equity in Indian companies more unlikely.

Given the decline in foreign investment in 2022 when compared to 2021, as well as given an unprecedented funding crush in the start-up industry (as discussed earlier), the budget was expected to rationalize regulations that would enable more flexibility in arranging incoming investments. Yet, such suggested modifications could have the opposite impact of driving out foreign capital from India. Although numerous businesses have recently contemplated internalization of their frameworks, the suggested changes made to the said section may lead to a choice for externalization of structures to promote adaptability in deal structure.

Furthermore, the whole point of introducing an angel tax is to tax an excessive share premium that is not supported by an appropriate value. Yet, according to FEMA guidelines, non-resident investors must have issued shares at a price not less than the value determined by the FEMA technique. As a result, the FEMA regulations establish a minimum value below which a private company can’t issue equity securities to non-resident investors. It seems that the government is contradicting its findings which one can draw through the bare reading of the memo as provided under the Finance Act, 2012.


To revisit the proposed 2023 budget by Indian Finance Minister (FM), Nirmala Sitharaman, Indian economic growth is estimated to be 7%, which is considered to be the highest predicted percentage among all the previous economic structures. But conflicts between FEMA and the Tax regime in the valuation of FMV shall be a roller coaster for the investment sector if the discussed amendment is not revisited. To avoid any disarray, authorities could think about coordinating the approaches to valuation between FEMA & the IT Act. Furthermore, clarity on the handling of convertible instruments, as well as the application of transfer pricing rules on the issuing of share capital at a premium to non-residents, would help to reduce disputes.


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