Angel Tax Exemption – Eligibility, Declaration, and Application Process

Angel Tax Exemption – Eligibility, Declaration, and Application Process

Angel tax is a levy imposed on startups in India when they receive investments exceeding their Fair Market Value (FMV), as specified under Section 56(2)(viib) of the Income Tax Act. To support entrepreneurship and encourage investments, the Indian government has abolished angel tax for all investor classes starting FY 2025-26. This decision is aimed at streamlining the funding process and fostering the growth of early-stage startups.

Previously, startups could apply for exemptions by registering with the Department for Promotion of Industry and Internal Trade (DPIIT) and fulfilling specific conditions, such as ensuring their paid-up capital and share premium did not exceed ₹25 crore. With the elimination of angel tax, these exemption requirements no longer apply, making the investment ecosystem more efficient.

Background on Angel Tax

India’s startup ecosystem has gained global recognition, attracting investors ranging from angel investors to venture capitalists. However, a significant challenge for startups has been the angel tax, which was introduced in the Finance Act of 2012 and became effective from April 2013.

This tax required startups to pay taxes on the difference between the amount of investment received and the FMV determined by the tax authorities. The excess amount was classified as income from other sources and taxed accordingly. For early-stage companies, this created a substantial financial burden, as assessing FMV for emerging businesses is inherently challenging.

Although the Union Budget 2019 introduced certain exemptions, they came with strict eligibility criteria, making it difficult for many startups to qualify. The angel tax, initially intended to curb money laundering, inadvertently became an obstacle for genuine startups seeking investment.

Key Takeaways

• Angel tax has been abolished from FY 2025-26 for all investor categories.
  
  

• Previously, DPIIT registration and specific conditions were required for exemption.
  
  

• Angel tax imposed a 30.9% tax on investments exceeding FMV, affecting startup funding.
  
  

• The move to eliminate angel tax is expected to simplify investment procedures and promote startup growth in India.

Understanding Angel Tax

Angel tax, as outlined in Section 56(2)(viib) of the Income Tax Act, 1961, applies to unlisted companies (startups whose shares are not publicly traded) when they receive investments exceeding their Fair Market Value (FMV). Any amount received above the FMV is categorized as "income from other sources" and is taxed at 30.9% (including a 30% income tax rate and 3% cess).

This provision specifically targets closely-held companies that issue shares to resident investors at a price higher than their fair market value. In such cases, the surplus amount is considered taxable income for the company receiving the investment. Introduced through the Finance Act, 2012, angel tax was established to prevent money laundering and regulate excessive share premiums in private companies.

Challenges with Angel Tax

The biggest challenge lies in determining a startup’s FMV. Unlike well-established businesses that have a clear market valuation, startups are in their early stages and often lack concrete financial records. The government’s FMV calculation is subjective and may not reflect the true potential of a startup.

For example, if an investor values your startup’s idea and invests ₹15 crore, but the government estimates the FMV of your shares at ₹10 crore, the ₹5 crore difference would be taxed as angel tax. This results in a heavy financial burden on startups, making it difficult for them to attract investments.

With angel tax now abolished from FY 2025-26, startups no longer have to worry about this restriction, making India’s startup ecosystem more attractive to investors and entrepreneurs. 

Investments Subject to Angel Tax

Angel tax applies when a startup receives funding that exceeds its Fair Market Value (FMV) as determined by the government. This tax is not limited to investments from angel investors (who provide early-stage capital) but can also apply to venture capitalists if the startup remains unlisted. The key factor is the difference between the investment amount and the government-assessed FMV—regardless of who the investor is.

What is an Angel Tax Exemption?

To support startups and encourage investment, the Indian government has introduced angel tax exemptions. Startups that are registered under the Department for Promotion of Industry and Internal Trade (DPIIT) are exempt from angel tax.

To qualify for this exemption, startups must apply to the Central Board of Direct Taxes (CBDT) with supporting documents. Once approved, they are no longer subject to angel tax, allowing them to attract investments without additional financial burdens.

With the abolition of angel tax from FY 2025-26, these exemptions will no longer be necessary, simplifying the investment process for startups in India. 

Eligibility Criteria for Angel Tax Exemption

To qualify for an angel tax exemption, startups must meet a two-fold eligibility structure as defined by the government. This includes:

1️⃣ Eligibility Criteria for Startup Recognition (DPIIT)
2️⃣ Eligibility Criteria for Tax Exemption under Section 56 of the Income Tax Act, 1961

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1. Eligibility Criteria for Startup Recognition (DPIIT)

A startup must first be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT). The following conditions must be met:

✅ The company must be incorporated as a private limited company, partnership firm, or LLP (Limited Liability Partnership).
✅ The startup’s turnover must not exceed INR 100 Crore in any previous financial year.
✅ It must be less than 10 years old from the date of incorporation.
✅ The business must focus on innovation, product/service improvement, or process enhancement with the potential for job creation or wealth generation.
✅ Companies formed by splitting or restructuring an existing business are not eligible.

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2. Eligibility Criteria for Tax Exemption under Section 56 of the Income Tax Act, 1961

Once DPIIT recognition is obtained, the startup can apply for an angel tax exemption if it meets the following criteria:

✅ The startup must be recognized by DPIIT.
✅ The total paid-up share capital and share premium (investment amount exceeding the face value of shares) must not exceed INR 25 Crore after the proposed investment.
✅ The calculation excludes investments received from:

• Non-resident investors
  
  

• Venture Capital Funds (VCFs)
  
  

• Venture Capital Companies (VCCs)
  
  

By meeting these conditions, a startup can secure exemption from angel tax, making it easier to attract investments and grow without additional tax burdens. 

What is the Angel Tax Exemption Declaration?

The Angel Tax Exemption Declaration is a formal commitment made by startups seeking exemption from angel tax. It ensures that the funds raised from investors are utilized for core business activities rather than personal or speculative investments.

This declaration must be submitted alongside the exemption application and requires the startup to adhere to investment restrictions for seven years from the financial year in which the shares were issued.

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Restricted Asset Categories Under the Angel Tax Exemption Declaration

🚫 Residential Property: Startups cannot invest in residential real estate, except if:

• The property is used for business operations.
  
  

• It is held as stock-in-trade (for startups in the real estate sector).
  
  

🚫 Non-Business Land & Buildings: Purchasing land or buildings for non-business purposes (e.g., personal assets) is restricted.

🚫 Non-Business Loans & Advances: Lending money outside the normal course of business is not allowed, except for startups in the lending sector.

🚫 Capital Contributions: Startups cannot invest in other entities (i.e., no funding other businesses).

🚫 Shares & Securities: Buying stocks, bonds, or securities of other companies is restricted.

🚫 Luxury Vehicles: Startups cannot purchase vehicles valued over ₹10 lakh, unless they are used for business purposes.

🚫 Non-Business Assets: Investing in jewelry, artwork, bullion, or any non-business assets is not permitted, unless held as stock-in-trade.

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Why is the Angel Tax Exemption Declaration Important?

✅ It ensures that investment funds are used solely for business growth.
✅ Helps prevent misuse of funds for personal gain.
✅ Strengthens government and investor confidence in the startup.
✅ Essential for securing angel tax exemption approval.

By adhering to this declaration, startups gain credibility, ensuring a smoother investment process while enjoying tax relief. 

How to Apply for Angel Tax Exemption?

The Indian government has streamlined the angel tax exemption process for DPIIT-recognized startups. Startups can now apply directly through the Startup India portal, making the process more efficient.

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Step-by-Step Guide to Apply for Angel Tax Exemption

🔹 Step 1: Login to the Startup India Portal

• Visit Startup India.
  
  

• Enter your login credentials to access your dashboard.
  
  

🔹 Step 2: Navigate to the Recognition Section

• Click on the ‘Dashboard’ tab.
  
  

• Select ‘DPIIT RECOGNITION’ from the menu.
  
  

🔹 Step 3: Locate and Open Form 56

• Scroll down and find Form 56.
  
  

• Click on ‘Click Here To Apply Form 56’ to open the form.
  
  

🔹 Step 4: Verify and Complete the Form

• Most details will be pre-filled from your Startup India registration.
  
  

• Manually complete:
  
  

• Point 9: Upload a signed angel tax exemption declaration (on the company letterhead).
  
  

• Point 10: Enter the date of signing the declaration.
  
  

🔹 Step 5: Submit the Application

• Upload the declaration in PDF format.
  
  

• Click ‘Submit’ to finalize the application.
  
  

🔹 Step 6: Application Review by Authorities

• DPIIT forwards your application to the CBDT (Central Board of Direct Taxes).
  
  

• The CBDT must respond within 45 days (approval or rejection).
  
  

🔹 Step 7: Confirmation of Exemption

• If approved, your startup will receive an email confirmation from CBDT at the registered Startup India email ID.
  
  

• This confirmation typically arrives within 1-3 weeks after submission.
  
  

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Key Points to Remember

✅ Ensure the declaration is accurate and on official letterhead.
✅ Follow up on application status through the Startup India portal.
✅ Maintain compliance with eligibility criteria for continued exemption benefits.

By following this streamlined process, eligible startups can secure angel tax exemption efficiently, ensuring uninterrupted growth and investment opportunities. 

Benefits of Angel Tax Exemption

The angel tax exemption in India provides a significant advantage to both startups and investors, fostering a more supportive funding ecosystem. Here are the key benefits:

✅ Reduced Financial Burden

• Eliminates the 30.9% tax on excess investment, allowing startups to retain more capital for operations and expansion.
  
  

✅ Easier Access to Funding

• With no heavy tax implications, angel investors are more inclined to fund early-stage startups, making it easier for them to secure investments.
  
  

✅ Enhanced Growth Potential

• The savings from tax exemption can be directed towards core business areas like product development, marketing, and hiring talent, accelerating innovation and scalability.
  
  

✅ Encouragement of Entrepreneurship

• The exemption encourages more individuals to launch startups, knowing they won’t be taxed unfairly on investments made at an early stage.
  
  

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Disadvantages of Angel Tax for Startups in India

While the angel tax was initially implemented to prevent money laundering, it has had several drawbacks, making it challenging for startups to thrive. Here’s why:

❌ Valuation Discrepancies

• Startups are valued based on future potential, unlike established businesses. Since FMV (Fair Market Value) assessment is subjective, startups may be unfairly taxed on investments that exceed government-determined FMV.
  
  

❌ Discouraging Investments

• The high angel tax rate (30.9%) discouraged angel investors from funding startups, reducing the flow of essential capital into the ecosystem.
  
  

❌ Unequal Access to Capital

• Initially, the angel tax only applied to resident Indian investors, creating a disparity where foreign venture capitalists (VCs) and NRIs were exempt. The new tax exemption has been extended, but NRIs still lack explicit inclusion, potentially limiting funding sources.
  
  

❌ Hindering Growth and Innovation

• A hefty tax bill diverts resources away from critical business activities, slowing down innovation, market expansion, and hiring.
  
  

The abolition of angel tax (effective FY 2025-26) marks a major relief for startups, ensuring a level playing field for funding and fostering a robust entrepreneurial ecosystem in India.

Angel Tax Example for Indian Startups

Consider a scenario where your startup has developed a cutting-edge mobile app that grabs the attention of an angel investor. They decide to invest ₹15 crore in exchange for equity.

However, the Indian government assesses your startup’s Fair Market Value (FMV) at only ₹10 crore. This creates a ₹5 crore excess investment, which—under the angel tax provision—would be taxed at 30.9%.

🔹 Tax Liability Calculation:

• Excess investment = ₹5 crore
  
  

• Tax rate = 30.9%
  
  

• Angel tax payable = ₹1.54 crore
  
  

This unexpected tax burden can put a strain on a startup’s finances, limiting its ability to utilize the full investment for business growth.

However, if the startup is recognized under DPIIT (Department for Promotion of Industry and Internal Trade), it can apply for an exemption, eliminating the angel tax liability. This exemption is crucial in preserving investor confidence and supporting startup growth.

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Conclusion

The angel tax, originally introduced to prevent money laundering, has unintentionally created financial obstacles for Indian startups. The high tax rate on investments exceeding FMV has discouraged angel investments, stifling growth in the startup ecosystem.

However, the exemption for DPIIT-registered startups offers much-needed relief, allowing them to retain more capital, attract more investors, and focus on scaling their businesses.

While challenges remain in navigating the application and valuation processes, working with tax professionals can help startups leverage the exemption effectively. Moving forward, striking a balance between encouraging legitimate investments and maintaining tax regulations will be key to boosting India’s startup landscape.