DPIIT-Registered Startups Granted Angel Tax Relief Regarding Shareholder Tax Returns


Three points you will get to know in this article:

  • Startups recognized by DPIIT and meeting specific conditions are exempted from Section 56(2)(viib)
  • To qualify for angel tax exemption, a startup’s combined value of paid-up share capital and share premium should not exceed INR 25 Cr
  • Experts believe INR 25 Cr limit is inadequate for startups
  • G.S.R. 127(E) circular makes ordinary business operations difficult for startups

Amidst the ongoing debate swirling around startups receiving notifications under Section 56(2)(viib), commonly known as the angel tax, and being tasked with presenting income tax returns (ITRs) from their stakeholders for the preceding three years, the Central Board of Direct Taxes (CBDT) has disseminated a circular to its esteemed senior field officers.

In this circular, it is clearly articulated that the stipulations of Section 56(2)(viib) of the Act won’t be applicable to startup entities that have earned recognition from the Department for Promotion of Industry and Internal Trade (DPIIT) and satisfactorily fulfill the conditions delineated in paragraphs 4(i) and 4(ii) of Notification No. G.S.R. 127(E).

This move by the CBDT offers a respite to startups meeting the specified criteria, aiming to alleviate the burden imposed by the angel tax controversy. It underscores the government’s acknowledgment of the crucial role played by these recognized startups in fostering innovation and economic growth.

In adherence to the provisions outlined in Notification G.S.R. 127(E) dated February 19, 2019, a startup becomes eligible for an angel tax exemption based on two key criteria – 4(i): The startup must have received recognition from DPIIT under paragraph 2(iii)(a) or in accordance with any previous notifications on the matter. Additionally, 4(ii) stipulates that the cumulative value of the startup’s paid-up share capital and share premium, following the issuance or proposed issuance of shares, should not surpass INR 25 Cr.

It’s crucial to underscore that when computing this value, shares allocated to venture capitalists are not included.

In this context, it’s noteworthy to highlight that the Finance Act of 2023 has brought about a modification to clause (viib) of sub-section (2) of Section 56 of the Act. This amendment, effective from April 1, 2024, entails the removal of the phrase ‘being a resident.’

This evolution in legislation marks a significant development in facilitating a more conducive environment for startups seeking angel tax exemptions.
In recent times, some emerging businesses have come under examination through the Computer-Assisted Scrutiny Selection (CASS) process. In light of these situations, we would like to clarify the steps involved in evaluating recognized startups that align with the criteria set by the Department for Promotion of Industry and Internal Trade (DPIIT), as detailed in paragraphs 4(i) and 4(ii) of the DPIIT notification.

According to the notification, if a startup undergoes scrutiny solely due to the applicability of Section 56(2)(viib) of the Act, those overseeing the assessment will abstain from conducting verifications on this matter during the proceedings under sections 147/143(2) of the Act. Furthermore, the concerns raised by acknowledged startups on this matter will be promptly acknowledged without further inquiry.

In cases where a startup is chosen for scrutiny involving multiple issues, including Section 56(2)(viib) of the Act, we want to assure you that the concerns related to angel tax will not be pursued.

Our aim is to make this process transparent and stress-free for startups, ensuring that they can focus on innovation and growth without unnecessary hurdles. If you have any questions or need further clarification, please don’t hesitate to reach out.

The Ongoing Challenges with Angel Tax

In shedding light on various critical concerns about the circular G.S.R 127(E) issued on February 19, 2019, Siddarth Pai, a key figure at 3One4 Capital, emphasized that the challenges posed by the circular significantly hinder the smooth functioning of regular business operations, making adherence nearly unattainable for any burgeoning startup.

Startups are prohibited from: for seven years following the previous time they issued shares at a premium;

• Give any loans and advances (apart from those to pending businesses)
• Buy shares and other securities
• Make investments in capital

Navigating this constraint poses hurdles for various initiatives, including facilitating salary advances, instituting an Employee Stock Ownership Plan (ESOP) pool, establishing subsidiaries, forging joint ventures, and leveraging stock for company acquisitions. Notably, the INR 25 crore threshold outlined in the circular is perceived as insufficient, particularly for startups eyeing substantial funding. Consequently, this circular falls short in addressing these pivotal issues.

Furthermore, there are substantial repercussions linked to breaches of these stipulations. Companies may find themselves subject to penalties equivalent to twice the tax amount owed, already fixed at 25%. Considering factors like interest, this results in a steep cumulative rate, reaching up to 90%. Consequently, the existing circulars prove inadequate in effectively tackling these critical concerns, leaving the startup community grappling with myriad unanswered questions and apprehensions.

Pai emphasized the ongoing challenge in assessing a company’s real performance against its projected figures, noting that this issue remains unsettled despite regulatory adjustments within the startup landscape. In tackling the matter of traceability, he suggested that companies opting for shares at a premium should consider dematerializing securities, thereby simplifying the process of tracking pertinent details. Additionally, he underscored the recent mandate requiring investors to disclose unlisted investments to the tax department, a move aimed at promoting transparency in the investment landscape.

For budding businesses, it’s crucial to promptly report any security issuances surpassing INR 10 Lakhs. This, coupled with the dematerialization process, establishes a clear traceable path for tax authorities. It enables them to track down individuals leveraging high-value investments to circulate undisclosed funds. Despite these efforts, the startup realm actively seeks more tangible and practical answers to these challenges.
To sum it up, while strides have been made to ease the burden of angel tax on acknowledged startups, lingering concerns, and uncertainties persist within the startup community. Collaborative efforts between the industry and regulatory bodies are imperative to craft effective solutions that cater to the ever-evolving needs of startups in India.

the Central Board of Direct Taxes (CBDT) has issued a circular exempting recognized startups from angel tax scrutiny under Section 56(2)(viib) of the Income-tax Act. Startups meeting the criteria outlined by the Department for Promotion of Industry and Internal Trade (DPIIT) will not be required to file Form 2 and will not face verifications or penalties related to angel tax.

However, the circular’s limitations on ordinary business operations and the INR 25 crore limit are seen as inadequate and fail to address key concerns within the startup community. Definitive solutions are still needed to address traceability and reporting issues.

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