Introduction
Startups in India often face unique challenges in securing early-stage funding. One such challenge is the taxability of share premium under Section 56(2) (viib) of the Income Tax Act, 1961 — commonly referred to as the “Angel Tax.”
As per the provisions of Section 56(2) (viib), any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be treated as Income from other sources and making it taxable at applicable rates. The section applies to the issuance of shares by the private companies at a value higher than the fair market value of the shares.
To facilitate ease of fundraising and to promote entrepreneurship, the Government has introduced specific exemptions for DPIIT-recognised startups from the rigors of Section 56(2) (viib). This article explains the significance of this exemption and why it is crucial for startups in India.
Need for Exemption – The Startup Perspective
1. Valuation Based on Potential, Not Assets
Startups typically raise funds based on scalability, future projections, and innovative potential, not on current financials or asset base. This often leads to share premium that cannot be justified using traditional valuation methods like NAV (Net Asset Value) or DCF (Discounted Cash Flow).
2. Fear of Tax Notices
In the absence of exemption, many startups were subjected to scrutiny, tax demands, and litigation solely on the ground that their share issue price was higher than FMV as determined by assessing officers. This discouraged both investors and founders.
3. Investor Confidence
Exemption under Section 56(2) (viib) provides certainty and assurance to investors, especially angel and seed investors, encouraging them to back startups during the initial, high-risk phases.
Conditions for Exemption
To avail exemption from Section 56(2) (viib), a startup must:
- Be recognized by the DPIIT (Department for Promotion of Industry and Internal Trade)
- Not invest in certain restricted assets for a period of seven years, such as:
- Immovable property (not related to business)
- Shares and securities
- Loans and advances (except in normal business course)
- File Form 2 with DPIIT.
- Maintain compliance with Startup India Guidelines
Recent Developments (as of May 2025)
In a recent move to boost the ecosystem, DPIIT has approved 187 additional startups for exemption under Section 56(2) (viib), reaffirming the Government’s commitment towards ease of doing business and reducing tax-related hurdles for entrepreneurs.
Conclusion
In my opinion as a practicing CA who works with startups, I can say this exemption has saved many founders from unwanted litigation and sleepless nights.
Startups need the freedom to raise funds based on their potential — not get punished for it later with tax notices. The Section 56(2)(viib) exemption provides this space.
That said, DPIIT recognition and Form 2 compliance shouldn’t be taken lightly. I’ve seen founders lose the exemption just because they missed a small step or timeline. The sooner startups take professional help and get their documentation right, the better.
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