Startups, VCs seek exemption from angel tax provisions for certain funds

The startup and venture capital industry, spooked by the spectre of angel tax being made applicable on foreign investments in unlisted companies, has asked the government to exempt certain classes of investors.

It has also requested the government to allow ‘internationally accepted valuation methodologies’ under the Section 56 the Income-tax Act.

The government in the Finance Bill this year has omitted the term ‘resident’ while referring to investors under the Section 56(2)(viib) of the Income-tax Act, thus making angel tax applicable on all foreign investments.


Several industry bodies have sent recommendations to the Department for Promotion of Industry and Internal Trade (DPIIT) and the Central Board of Direct Taxes (CBDT), as per sources.

The industry has recommended exempting classes of investors “who are a lower risk of circulating unaccounted money”. This includes foreign portfolio investors (FPIs) and foreign venture capital investors (FVCIs) registered with SEBI; companies listed on recognised stock exchanges regulated by financial services regulators recognised by the International Organization of Securities Commissions (IOSCO); endowments associated with hospitals, universities and charities; private equity funds, venture capital funds, hedge funds wherein the fund or manager is regulated by financial services regulators recognised by the IOSCO, as well as financial institutions like banks, insurance companies, asset management companies, portfolio managers, wealth advisors, investment advisors.

It has also asked sovereign wealth funds, controlled and regulated by the government of a foreign country, to be exempted.

Additionally, the industry has also sought exemptions for accredited investors as specified by financial services regulators recognised by the IOSCO, and accredited investors registered with the accreditation agency as per the SEBI AIF regulations.

Given that the valuation is the crux of the angel tax issue, the industry bodies are also seeking a change in the current requirement of a discounted cash flow (DCF) valuation under Section 56(2)(viib).

The industry has recommended a change in “internationally accepted valuation methodologies”, especially to those recommended under the International Private Equity and Venture Capital Valuation (IPEV) guidelines.

The valuation methodology has become a contentious point, given that it differs between the FEMA (Foreign Exchange Management Act) rules and the Income-tax Act. Under FEMA, shares cannot be given to foreign investors below the fair market value. But under the Income-tax Act, the fair market value is treated as a ceiling and thus, any funding above that value is taxed.