13 August, 2018
Angel Tax Exemption Notification
Section 56(2)(viib) of the Income-tax Act, 1961 (‘IT Act ’) provides that where a closely held company issues its shares at a price which is more than its fair market value (‘FMV ’), the amount received in excess of fair market value will be charged to tax in the hands of the company as income from other sources. The section further prescribes various methods for valuation of FMV of shares of the closely held company. Amongst the various options for valuation of FMV , one of the methods prescribed is determination by a merchant banker or an accountant as per the ‘Discounted Free Cash Flow Method’.
The Central Board of Direct Taxation (‘CBDT ’) had, on June 14, 2016, issued a notification providing that investments received by ‘start-ups’ (as specified in the Department of Industrial Policy and Promotion (‘DIPP ’)) would not be subject to taxation under Section 56(2)(viib) of the IT Act (‘Angel Tax Exemption ’).
The DIPP issued a notification on April 11, 2018 specifying the procedure and criteria for start-ups to avail tax benefits (‘DIPP Notification ’). This DIPP Notification had specified three key conditions for availing the Angel Tax Exemption: (i) aggregate amount of paid-up share capital and share premium, after the proposed issue of shares, does not exceed . 10 crore (approx. US$ 1.5 million); (ii) investor/ proposed investor fulfils the prescribed criteria; and (iii) startup procures a report from a merchant banker, specifying the FMV of shares in accordance with applicable rules.
Pursuant to the DIPP Notification, the CBDT has on May 24, 2018 also notified that the provisions of Section 56(2)(viib) of the IT Act will not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification as per the notification issued by the DIPP Notification. Simultaneously, the CBDT has issued another notification on May 24, 2018 making merchant banker valuation mandatory for the purposes of Section 56(2)(viib) of the IT Act by removing reference to ‘accountant’ in the valuation rules.
POEM Rules on Tax Computation
The concept of ‘place of effective management’ (‘POEM ’) for deciding tax residency statusof a company other than an Indian company was introduced in the IT Act and made effective from April 01, 2017. The CBDT has now issued a notification on June 22, 2018 specifying certain exceptions, modifications and adaptations from the normal provisions of IT Act applicable in case of such companies regarding computation of income, set-off or carry forward of losses, collection and recovery and tax avoidance, to apply to a foreign company having POEM in India.
These rules cover only such income of the foreign company which is taxable in India specifically due to the existence of the POEM of that company in India. Key points of the notification are as below: i. Status and Tax Rate : The foreign company which is considered resident in India on account of having POEM in India will nevertheless continue to be treated as a foreign company for the purposes of the IT Act. In case of a conflict between the provisions applicable to such foreign company as a foreign company and as a
resident, the provisions applicable as a foreign company will prevail. The tax rate applicable to a foreign company which is considered resident on account of having POEM in India is the same as applicable to any foreign company (40% plus applicable surcharge and cess) which is higher than the rate prescribed for domestic companies (30% plus applicable surcharge and cess).
ii. Tax withholding obligations on payments made to the foreign company : Where more than one tax withholding provision is applicable to the foreign company i.e. as a resident as well as a foreign company, the provision applicable as a foreign company alone will apply. Additionally, compliance to the tax withholding provisions as are applicable to the foreign company prior to its becoming a person resident in
India would be treated as sufficient compliance of the tax withholding provisions.
iii. Credit for Foreign Taxes : The foreign company having POEM in India would be entitled for credit of foreign taxes against Indian income-tax liability.
iv. Carry forward and set-off of losses and depreciation allowance : The notification sets out detailed mechanism for off-setting accumulated losses and unabsorbed depreciation of the foreign company against its taxable income and for determining the written down value of depreciable assets in the hands of the foreign company.
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
