Angel Tax- Impact on Foreign Investment


The Finance Act of 2012 introduced a well-known tax known as the ‘angel tax’ in section 56(2) (vii b) of the Income-tax Act, 1961 (ITA). The angel tax’s original purpose was to discourage shell companies’ existence and prevent the circulation of undisclosed funds. The angel tax applies to companies in which the general public does not have a significant interest when they receive consideration for issuing shares that exceed then they receive consideration for giving shares that exceed the fair market value (FMV) of those shares. The surplus consideration received by such Indian companies is treated as taxable income from some other sources. However, until March 31, 2023, this tax only applied to investments received from Indian residents.

The ‘angel tax,’ a term commonly used to refer to this provision, was initially introduced in 2012 to discourage the generation and utilization of undisclosed funds using subscribing to shares of a privately held company at a value higher than the fair market value of the company’s shares.

According to this provision, if an unlisted company, like a startup, receives equity investment from a resident in exchange for issuing shares that surpass the nominal value of those shares, it will be considered Income for the startup. As a result, the startup will be liable to pay income tax under the ‘Income from other Sources’ category for the relevant financial year.

Notified Categories of Exempted Investors from Angel Tax

In a notification issued on May 24, the Central Board of Direct Taxes (CBDT) provided a list of entities exempted from certain regulations. These excluded entities include those registered with the Securities & Exchange Board of India (SEBI) as Category-I Foreign Portfolio Investors (FPI), Endowment Funds, Pension Funds, and broad-based pooled investment vehicles with over 50 investors. Residents of 21 specified nations, such as the United States, Australia, Germany, United Kingdom and Spain, are also included in the list.

The notification also mentions other countries: Austria, Canada, Czech Republic, Belgium, Denmark, Finland, Israel, Italy, Iceland, Japan, Korea, Russia, Norway, New Zealand, and Sweden. It is important to note that the CBDT’s notification came into effect on April 1, 2023. The notification was released after a press release issued by the CBDT on May 19, 2023, which provided comprehensive information about the categories of investors exempted from the angel tax provision. However, stakeholders must await an official notification regarding valuation guidelines, as the press release outlined five methods.

Additional entities exempted from the provision include government and government-related investors, i.e., central banks, sovereign wealth funds, international or multilateral organizations or agencies, and entities controlled by the government or have government ownership of 75 percent or more. Moreover, banks or entities engaged in the insurance business are exempted if they are subject to the relevant regulations in the country where they are established, incorporated, or reside.


Concerns Regarding the Exemption

The decision to exclude Mauritius, Singapore, and the Netherlands is perceived as an effort to address the loopholes associated with investments originating from these tax havens. However, experts also anticipate that excluding these countries could affect the fundraising activities of startups, as they heavily rely on investments from these sources.

Bhavin Shah, who holds the position of Deals Leader at PwC India, expressed appreciation for the relaxation measures introduced to facilitate foreign investments. However, he noted that the exemption for broad-based funds is limited to 21 countries, excluding significant jurisdictions such as Singapore, Mauritius, and the UAE. These three countries collectively contribute more than 50% of India’s Foreign Direct Investment (FDI). The absence of these countries from the exemption list keeps prominent private equity/venture capital funds and the startups they invest in on alert regarding the angel tax issue. These funds presently account for nearly half of the foreign investment in the country.

It is further mentioned that the exemption for angel tax applicable to startups covers less than 2% of startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT) due to the extensive list of conditions they must fulfill over seven years. Consequently, the exemption exists only on paper. He emphasized the need to swiftly bridge the gap between policy intent and implementation to make up for lost time and seize the current opportunities available to Indian entrepreneurs. Rakesh Nangia, Chairman of Nangia Andersen India, stated that the explicit mention of this list of countries aims to attract more Foreign Direct Investment (FDI) into India from nations with robust regulatory frameworks.


Impacts on Foreign Investment

The exclusion of investments made by government or government-related investors, including Sovereign Wealth Funds (SWFs), banks, and insurance entities, from the angel tax provisions is seen as a positive development. It is worth noting that investments from such government-related investors, regardless of the jurisdiction they originate from, continue to be exempted from angel tax provisions. The exemption list also includes entities that are controlled by the government or have direct or indirect government ownership of 75% or more. Consequently, investments made by a Special Purpose Vehicle (SPV) with government ownership, whether direct or indirect, will also be exempted from angel tax provisions.

Investments by specified entities These entities comprise residents of the 21 countries that have been notified by the Central Board of Direct Taxes (CBDT). Notably, countries such as Australia, France, Italy, Japan, United Kingdom, and the United States are included in this list. However, it is surprising that countries like Mauritius, Singapore, the Netherlands, and the UAE, which contribute to over 50% of India’s Foreign Direct Investment (FDI), have not been included. As a result, investments made by Category-I Foreign Portfolio Investors (FPIs), pension funds, or investment funds from jurisdictions like Mauritius, Singapore, the Netherlands, and the UAE will be subject to angel tax provisions. This may discourage foreign investments from these intermediary jurisdictions.

Broad-based investment funds are now exempt from the angel tax provisions. The exemption is based on the number of investors at the level of the investment fund itself rather than a look-through approach. Typically, investors invest through a feeder vehicle, which pools the investments into a master fund that ultimately invests in portfolio companies. The threshold of having 50 or more investors is expected to limit the number of investment funds that qualify for this exemption. The concept of ‘broad-based’ funds has been inspired by the previous Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations from 2014, which considered investors on a look-through basis. Although the current Foreign Portfolio Investors (FPI) Regulations have removed the concept of broad-based funds, it would have been beneficial to include the look-through provision in the Exclusion Notification.

Investments made by Alternative Investment Funds (AIFs), including those set up in the International Financial Services Centre (IFSC), that are registered with the Securities and Exchange Board of India (SEBI) or regulated under the IFSCA Act, are not subject to angel tax provisions. This exemption will likely make AIFs more appealing in India, and investors may also consider establishing captive AIFs in IFSC for specific individual investments.



Although the proposed changes are a positive step and offer some relief to the industry, significant issues remain in relation to angel tax. Concerns may arise about the constitutional validity of Section 56(vii b). These concerns stem from delegating authority to income tax authorities, allowing them to replace share valuations determined through commercial negotiations. This delegation of power may be seen as excessive and arbitrary. Furthermore, the tax on capital can be viewed as an unreasonable restriction on the right to conduct business, a right guaranteed under Article 19(1) (g) of the Constitution of India. In a climate where foreign investment in India has declined, ensuring the inflow of foreign capital will depend on the practical implementation of exclusions and valuation rules prescribed by the government. The government must reconsider the tax policy surrounding the taxation of capital investments.

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