I-T Department Notifies "Angel Tax" Rules For Valuing Investments In Startups

The Income Tax Department has introduced new rules for valuing investments in startups, addressing concerns related to ‘Angel Tax.’ Effective from September 25, these changes to Rule 11UA of the Income Tax Act offer more flexibility to taxpayers by allowing valuation based on fair market value for compulsorily convertible preference shares (CCPS) and unquoted equity shares.

The updated rules include five valuation methods for consideration from non-resident investors, namely the Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method, and Replacement Cost Method.

Experts from Nangia & Co LLP and AKM Global Tax appreciate the positive impact of these changes. They emphasize the enhanced efficiency, fairness, and clarity in tax assessments, benefiting both taxpayers and the government. The inclusion of a tolerance threshold for minor valuation discrepancies and the extension of a 10% safe harbor to CCPS investments are particularly welcomed.

The amendments aim to align the valuation rules with the Foreign Exchange Management Act (FEMA) and simplify the process of taxing investments above fair market value. Earlier, this tax, commonly known as ‘Angel Tax,’ applied to investments by domestic investors in closely held or unlisted companies. With the recent changes in the Finance Act, this tax is applicable irrespective of the investor’s residency.

These developments are expected to encourage venture capital investments, attract foreign investments, and provide a clear valuation mechanism for CCPS investments, ultimately fostering growth in the startup ecosystem.