Section 56 of the Income Tax Act, 1961 (ITA) seeks to tax “income from other sources” of a taxpayer. Section 56(2)(viib) levies tax on a private company on issuance of shares, if such shares are issued at a price higher than their fair market value. The provision exempts situations where the consideration is received by: (a) a non-resident; (b) a venture capital undertaking from a venture capital company or fund; or (c) a company from a class, or class of persons, notified by the central government.
The provision proved particularly egregious to startups and early-stage companies with limited capital, which would be required to part with a significant portion of funds obtained by them from investors in lieu of equity – hence the phrase “angel tax”. The government has issued various notifications time and again under exemption (c), mentioned above, to provide thrust to the startup ecosystem.
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