Extension Of ‘Angel Tax’ Provisions To Non-Residents: Is the Proposed Change Angelic Enough?



The Union Budget 2023, presented by Finance Minister Nirmala Sitharaman, proposed an amendment via the Finance Bill 2023 to Section 56(2)(vii-b) of the Income Tax, 1961. The amendment extends the applicability of the ‘Angel Tax’ to the funding received by privately held, unlisted companies from ‘non-residents’. This tax was previously levied only on the funding received from affluent ‘residents’ or high-net-worth individuals of the country. The provision was introduced in 2012 to mainly combat money laundering, corruption, and tax evasion. The imposition of such a tax is intended to increase transparency.

However, due to its extension to non-residents, the proposed amendment is set to adversely impact the financing of start-ups, which has been showing a trend since 2022. Funding received by Indian startups has been showing a downward trend since 2022 and has plunged nearly 33% when compared to the previous year.

This article intends to study the details of the proposed amendment and its impact on the start-up culture of the country. The apparent conflict pertaining to the calculation of the Fair Market Value (‘FMV’), between the Foreign Exchange Management Act, (1999) (‘FEMA’) and the Income Tax Act 1961 (‘IT Act’) has been highlighted. Moreover, the status of such a tax under different jurisdictions and initiatives taken by foreign governments to promote the start-up industry has also been put forth.  

Details of the Provision and the Proposed Amendment

Angel investors generally invest in firms where they see growth prospects. A corollary of the same is that they usually opt for convertible debt or ownership equity due to the unpredictability and volatility of the markets. This tax is imposed on the amount that startups receive while selling shares at a premium. When the shares of a company are sold at a higher share price than their FMV, the government taxes the excess income accordingly under the head of ‘Income from other sources’. This provision was introduced in 2012 because, then, the common practice was that of converting black money to white money by investing in shell companies. Therefore, its purpose was to mainly combat money laundering, corruption, and tax evasion.

The introduction of such a provision was certainly a welcome move. However, there exists no mechanism to assess the genuineness of a transaction. As a result, due to the indistinguishability between bonafide and mala-fide transactions, these ventures suffer.  Therefore, the imposition of the same on finances raised from ‘non-residents’ might be detrimental to the growth of startups in India given that the government is majorly focussing on foreign direct investment, investment facilitation, and the ease of doing business in the Indian economy. 

In this context, it is also pertinent to discuss certain exemptions from the applicability of the angel tax provided via the exemption notification of 2019. It stated that only ‘start-ups’ recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) and whose total paid-up share capital and share premium after the issuance or intended issuance of shares, if any, do not exceed Rupees 25 Crores are eligible for the exemption. This is limited by the requirement that start-ups must not have invested in or would not invest in the class of assets that includes immovable properties, loans and advances, capital contributions to other entities, shares and securities, motor vehicles, or any other mode of transportation, jewelry, or any other asset class. Funds from non-resident investors shall not be included in computing the aforesaid threshold. However, it is expected that the exempted categories would also be amended soon to align them with the proposed amendment. 

Implications of the Proposed Amendment

Interestingly, the proposed amendment presents a dilemma for startup companies. This is because of the induced compulsion to raise shares at FMV. FEMA disallows the issuance of shares below the FMV and the IT Act taxes the amount raised in excess of the FMV. Therefore, startups are constrained to issue shares at the FMV.

At a time when the startup industry is growing rapidly, with the most significant number of unicorns in India after the USA and China, this government initiative seeks to dampen the enthusiasm and growth prospects. The reason is that foreign investors are the major source of funding for start-ups in the country. India also provides for various schemes to promote and enhance the growth of startups. These initiatives include the Startup India Seed Fund Scheme, the Startup India initiative, and Startup Accelerators of MeitY Product Innovation and Growth (SAMRIDH). However, a provision like an angel tax may have an adverse effect on the advantages of these schemes. The growth of startups, as a result, may be impeded. An obvious outcome could also be apprehension amongst foreign investors due to the increased risk of litigation about the subjective valuation of the company, which is often challenged by tax officials. Due to the application of angel tax, these startups come under the close scrutiny of tax officials, since the excess amount is to be accounted for. The income tax provisions provide for a valuation mechanism for unquoted equity shares which permits the usage of net asset value (formula-based) or discounted cash flow approach as determined by a merchant banker. This creates subjectivity. A higher valuation is likely to be questioned by tax officials, and angel tax would be levied on the excess amount raised.

Further, with the ambit of the ‘angel tax’ extended, startups would want to shift or establish their base in foreign countries where such tax restrictions are not applied. Such a move may also lead to ‘externalization’ which is the transfer of ownership to a holding company that is based in a conducive business environment in a foreign jurisdiction. This would further impact employment generation and the ease of doing business in the country. Therefore, it is hoped that the government will reconsider this proposed amendment given the complex consequences that are to ensue. 

Position of ‘Angel Tax’ In Foreign Jurisdictions

It is pertinent to note that angel tax is not a widely recognized concept in foreign jurisdictions. It is not surprising that such a tax, which disincentivizes funding for startups and the overall growth of the startup culture in the country, has not been adopted by other countries. 


In Canada, there is no specific angel tax provision, but there exist tax credits and incentives for investors who invest in certain types of companies, including startups. For example, the Canadian government offers the Scientific Research and Experimental Development (‘SR&ED’) tax credit to encourage investment in research and development. 

Canada offers low business taxes for companies and a very good business climate. Total business tax costs here are by far the weakest among the G7 countries.
Companies investing in Canada can benefit from a range of incentives and tax credit programs including the Global Skill Strategy, Accelerated Investment Incentive, and Innovation Superclusters initiative.


The Australian government, under its National Innovation and Science Agenda (NISA), provides for a ten-year exemption on capital gains tax for investments held as shares for more than 12 months. The scheme also provides for a 20 percent non‑refundable carry-forward tax offset on amounts invested in qualifying early-stage innovation companies (ESICs). Moreover, the country also provides capital gains tax exemptions to eligible foreign investors on their share of capital or revenue gains made under Venture Capital Limited Partnerships (VCLPs).  Such measures as providing tax offsets at the funding stage contribute to developing a healthy startup culture in the country.

United Kingdom

In the United Kingdom, the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) provide tax relief for investors. The UK has tried to maintain a congenial environment for attracting foreign direct investment. The country also imposes foreign equity ownership restrictions in a limited number of sectors. However, the UK’s decision to implement the improved National Security and Investment Act unfavorably affects the startup ecosystem in the country. The Act aims to investigate hostile foreign direct investment that threatens UK’s national security.  


The USA does not have a central law for angel investments. However, it passed the Protecting Americans from Tax Hikes (PATH) Act of 2015 by amending Section 1202 of the Internal Revenue Code. This has made permanent a 100 percent exclusion from capital gains tax for any gains on long-term investments in qualified small businesses, up to 10 million dollars or ten times the original investment, whichever is greater.


China provides tax incentives to venture capitalists that invest at the seed capital stage. 70 percent of the investment amount can be offset against the taxable income of the venture capital enterprise for Corporate Income Tax (‘CIT’) purposes. Small businesses (whose annual income does not exceed RMB three million) have enjoyed a low CIT rate (2.5%) since 2020, up to a revenue of RMB one million. Small and Low-Profit Enterprises (‘SLPE’) are subject to a 20 percent CIT rate on 25 percent of their taxable income amount after the adjustment.  Therefore, the effective CIT rate for SLPEs is currently 5 percent. Because the SLPE evaluation is carried out at the entity level (instead of at the group level), small subsidiaries of foreign multinational enterprises (MNEs) in China can also benefit from these CIT cuts.

Therefore, there do not exist any specific angel tax provisions in prominent foreign jurisdictions. These countries may serve as the perfect opportunity to escape the application of the angel tax provision, thereby leading to externalization, as discussed above. They function as tax havens, incentivizing the funding process for non-residents and subsequently benefiting the company.


In light of the above discussion, certain further amendments or notifications on the part of the government are expected to clarify the apparent conflict between the two laws. It is also imperative to consider that there already are various acts that govern and control these transactions in India, including the IT Act and FEMA. This raises pertinent questions as to the need for such a provision in the Indian context. Moreover, startups find it burdensome to bear the levy of this tax, as most of the funding received from non-residents goes into paying it. Since there are more unfavorable effects of the proposed amendment than favorable ones, it is imperative that the government reconsider the amendment before its implementation.

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