Section 56(2)(viib)Angel Tax on Share Premium

How it works

Section 56(2)(viib) was introduced as an anti-money-laundering measure and became, in practice, the single most complained-about provision in Indian startup taxation. The logic was that a closely held company issuing shares far above their fair value might be laundering unaccounted money in as share premium. The mechanism was to treat the excess of consideration over fair market value as the company's income from other sources and tax it.

The difficulty was that this is exactly what a genuine early-stage funding round looks like. A startup with negligible assets, no profits, and a large addressable market raises at a valuation reflecting its prospects, not its balance sheet. Under the prescribed valuation methods, particularly where the net asset value approach was preferred to a discounted cash flow projection, most of that premium looked like excess. The company, having just raised money to spend on growth, would face a tax demand on the capital it had raised. Investors were unaffected; the startup absorbed the whole charge.

Valuation was where the disputes actually happened. Where a company supported its premium with a discounted cash flow valuation, assessing officers frequently challenged the projections after the fact, comparing forecast revenue against what the business went on to achieve and treating the shortfall as evidence the valuation had been inflated. A substantial body of appellate decisions built up around whether hindsight is a legitimate basis for rejecting a forward-looking valuation, and the weight of authority came to favour the taxpayer, but only after years of litigation per case.

Relief for startups came through exemption rather than repeal. A DPIIT-recognised startup that met prescribed conditions, including a ceiling on paid-up capital and share premium and restrictions on the assets it could hold, could file a declaration and stay outside the charge. The conditions were narrow enough that a meaningful number of recognised startups could not use the exemption, and compliance with the asset restrictions constrained what the company could do with its own money.

The provision has since been withdrawn, which removed the charge prospectively. It has not removed the problem historically: assessments, appeals, and demands relating to years when it applied continue to work through the system, and a company that raised at a premium during those years may still be dealing with it. Anyone facing an open assessment on this should treat the accumulated appellate reasoning on valuation as the substance of their defence.