Angel tax — the informal name for Section 56(2)(viib) of the Income Tax Act — remains one of the most misunderstood threats to startup fundraising in India.
What is Angel Tax?
When a closely-held company issues shares to a resident investor at a price exceeding the fair market value (FMV) of those shares, the excess amount is treated as income from other sources and taxed at 30%+.
Example: Startup raises ₹5 crore from an angel for 20% stake. FMV = ₹3.5 crore for the same stake. Angel tax applies on ₹1.5 crore = tax liability of approximately ₹46 lakh.
The DPIIT Exemption
DPIIT-recognised startups can claim a complete exemption by filing Form 2 with the DPIIT. This applies to investments from both resident and non-resident investors, subject to the ₹25 crore aggregate investment ceiling.
Requirements: DPIIT recognition must be active at time of investment, Form 2 must be filed, and the startup must not invest in specified assets within 7 years.
Valuation Methods
- Net Asset Value (NAV) method: Straightforward but typically produces low valuations for asset-light startups
- Discounted Cash Flow (DCF) method: More appropriate for growth-stage companies; allows projection of future cash flows to justify investor valuation
Protecting Your Funding Round
- File for DPIIT recognition before your funding round closes
- Obtain a merchant banker valuation certificate at the time of every fundraise
- File Form 2 within the prescribed timelines after each investment