Angel tax

Angel tax is the informal name given to a provision under Section 56(2)(viib) of the Income Tax Act, 1961, which treats the amount received by an unlisted company from investors above the fair market value (FMV) of its shares as taxable income in the hands of the company. In a typical angel or pre-seed round, investors pay a premium over face value based on a negotiated valuation — but if the Income Tax Department determines that the FMV was lower than what investors paid, the excess is taxed as 'income from other sources' at corporate income tax rates.

For founders, this creates a counterintuitive situation: raising equity from an investor and having shares valued at a premium — which is the normal mechanics of venture funding — can trigger a tax demand even when no revenue was earned. This makes early fundraising more complex, as startups must obtain formal valuations from merchant bankers and ensure their documentation is in order before closing a round.

The provision historically applied only to resident Indian investors but was later extended in scope, before subsequent amendments and exemptions provided relief for DPIIT-recognised startups that meet prescribed conditions. Under current norms, a DPIIT-recognised startup that has the required certification can seek exemption from angel tax, removing the risk of a tax notice on the premium received.

Angel tax remains an important concept for founders to understand because the exemption is not automatic — it requires proactive compliance (timely applications, proper valuation reports, and maintaining recognition status). Lapsed recognition or missing documentation can re-expose a startup to the provision. It is also a common topic during investor due diligence, as investors want assurance that the company's capital receipts are clean.