Share Premium Tax Above FMV: End of Section 56(2)(viib), Section 92(2)(m) Continues, Tax Gap Emerges

Taxation of Share Premium Above Fair Market Value: The Sunset of Section 56(2)(Viib), The Continuity of Section 92(2)(m), And The Emerging Taxation Vacuum

I. Introduction

Twelve years after its introduction, the taxation of amount received against share capital exceeding its fair market value, legislated through Section 56(2)(viib) of the Income-tax Act, 1961 (“the 1961 Act”) was quietly extinguished by the Finance Act, 2024, with effect from Assessment Year 2025-26. The Finance Minister, in her Union Budget speech of July 2024, cited the objective of boosting India’s startup ecosystem and simplifying investment structures. The provision, originally conceived as an anti-abuse measure to curb the laundering of unaccounted money through inflated share premiums paid to closely held companies, had long drawn criticism from the startup community, investors, and practitioners alike for generating protracted valuation disputes, deterring legitimate investment, and creating compliance uncertainty.

However, the motive that removed Section 56(2)(viib) from the 1961 Act has left behind a notable and arguably deliberate vacuum: where a person pays a price for shares of a closely held company that far exceeds the fair market value (“FMV”) of those shares, neither the company nor the investor attracts any income-tax liability under the current framework. The companion provision, Section 56(2)(x) of the 1961 Act [now Section 92(2)(m) of the Income-tax Act, 2025 (“the 2025 Act”)], which taxes under-priced transactions in the hands of the recipient, does not grasp the scenario of overpayment at all.

This article examines the legislative journey of Section 56(2)(viib), the mechanics of its sunset, the scope and limitations of Section 92(2)(m) of the 2025 Act, the structural gap that results from their combined operation, and the risk that this gap may be exploited for sham transactions, while also surveying the existing anti-avoidance provisions that tax authorities retain.

II. Background: The Angel Tax and Its Rationale

Section 56(2)(viib) was inserted by the Finance Act, 2012, to address a specific and well-recognised mode of introducing unaccounted cash into the economy. The mechanics were straightforward: a closely held company would issue shares at a price vastly in excess of their intrinsic or market value; the “investor”, often a shell entity or accommodating party, would pay the inflated premium and the company would receive a large sum of money, documented as legitimate share capital, while the actual economic substance of the transaction was nil or negligible.

The provision addressed this by treating the excess of consideration over FMV as “Income from Other Sources” in the hands of the issuing company. FMV for this purpose was determined in accordance with Rule 11UA of the Income-tax Rules, 1962, using either the Discounted Cash Flow (“DCF”) method or the Net Asset Value (“NAV”) method, as elected by the company, though the Assessing Officer retained the power to dispute the valuation adopted.

Over twelve years, the provision attracted significant criticism on the following grounds:

• Valuation methodologies under the Income-tax Rules were often irreconcilable with commercially accepted startup valuation approaches, leading to systematic discrepancies.
• Assessing Officers exercised wide discretion in rejecting valuations, generating large additions and protracted appellate litigation.
• DPIIT-recognised startups, though afforded conditional exemptions from time to time, were still often caught within the provision’s net due to compliance gaps or threshold breaches.

Faced with mounting evidence that the provision was impeding the growth of India’s startup ecosystem without effectively curbing the money laundering it was intended to address, the Government announced the abolition of the angel tax in the Union Budget 2024.

III. The Sunset of Section 56(2)(viib): A Decision Without Stated Reasons

The Memorandum Explaining the Provisions in the Finance Bill, 2024 records the following legislative decision:

“It has been decided by the Government to sun-set the provisions of clause (viib) of sub-section (2) of section 56 of the Act. Consequent to said decision, amendment to clause (viib) of sub-section (2) of section 56 of the Act is being carried out to provide that the provisions of this clause shall not apply from the assessment year 2025-26.”

What is immediately apparent from this extract is the deliberate absence of any reasoning or policy justification for the sunsetting. The Memorandum does not explain why the anti-abuse objective of the provision was being abandoned, what alternative mechanism was being put in its place, or how the risk of money laundering through share premium would henceforth be managed.

This is not merely an academic concern. In Indian tax jurisprudence, the Memorandum Explaining the Provisions is a primary extrinsic aid to construction. The absence of stated reasons in the Memorandum signals, at minimum, that the legislature did not consider the resulting vacuum, or alternatively, that it consciously accepted it as the price of removing a provision widely seen as hostile to the startup ecosystem.

The sunset was made effective from Assessment Year 2025-26, i.e., from 1st April 2025, with Clause 23 of the Finance Bill, 2024 effecting the relevant amendment to Section 56(2)(viib) of the 1961 Act.

IV. Section 92(2)(m) of the Income-tax Act, 2025: Carrying Forward the Recipient-Side Tax

The Income-tax Act, 2025 (“the 2025 Act”), which consolidates and replaces the 1961 Act with effect from 1st April 2026, preserves the framework of taxing certain receipts without consideration or at below FMV prices. Section 92(2)(m) of the 2025 Act is the successor to Section 56(2)(x) of the 1961 Act and reads as follows (in relevant part):

Section 92(2)(m): where any person receives in any tax year, from any person or persons – (i) any sum of money without consideration, the total of which exceeds ₹50,000, the whole of such sum; … (iii) any property, other than immovable property – (A) without consideration, the aggregate fair market value of which exceeds ₹50,000, the whole of the aggregate fair market value of such property; (B) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding ₹50,000, the aggregate fair market value of such property as exceeds such consideration.

Two features of this provision are critical to the present analysis. First, Section 92(2)(m) taxes the recipient when they receive property (including shares and securities, which are expressly included in the definition of “property” under Section 92(5)(f)(ii) of the 2025 Act) for a consideration that is less than FMV. The excess of FMV over consideration paid is what is brought to tax.

Second, and crucially, Section 92(2)(m), like its predecessor Section 56(2)(x), has no application whatsoever to a situation where the consideration paid exceeds the FMV of the property received. The provision is structured as a one-way anti-undervaluation check. It does not address overpayment. This structural feature is not a flaw, it was by design in the context of Section 56(2)(x), which was intended to check gifts and near-gifts masked as arm’s length transactions. The overvaluation scenario was separately addressed by Section 56(2)(viib), which is now gone.

V. The Taxation Vacuum: A Worked Illustration

The following example illustrates the gap with precision. Consider a closely held private limited company (“Co. A”) whose shares carry a face value of ₹10 and whose FMV, determined under Rule 11UA of the Old Income-tax Rules, is also ₹10. A subscriber, individual or corporate, acquires 1,00,000 shares of Co. A at a price of ₹1,000 per share, paying total consideration of ₹10 crore. The FMV of the shares so acquired is ₹10 lakh. The premium paid over FMV is therefore ₹9.90 crore.

The tax analysis, post 1st April 2025, is as follows:

• Company (Co. A): Section 56(2)(viib) having been sunset, Co. A has no income-tax liability on account of the receipt of ₹9.90 crore as share premium above FMV. The entire ₹10 crore is received as share capital and securities premium, neither of which constitutes taxable income under any surviving provision of the 1961 Act (or the 2025 Act).
• Investor: Section 92(2)(m) of the 2025 Act (equivalent to Section 56(2)(x) of the 1961 Act) is not attracted because the investor has paid more than FMV, not less. There is no receipt of property at below-FMV consideration. The investor’s acquisition is simply an expensive purchase; the difference between the price paid (₹1,000) and the FMV (₹10) is economically a loss, not a taxable gain.

The result: the ₹9.90 crore premium on shares over FMV flows into Co. A, entirely tax-free in the company’s hands, in the investor’s hands, and in any other person’s hands, under the current statutory framework. The position is identical under both the 1961 Act (from AY 2025-26) and the 2025 Act (from AY 2026-27).

It bears emphasis that this outcome is not a legislative accident in isolation. The 2025 Act, which was enacted with full awareness of the Finance Act, 2024 amendments, chose not to reintroduce any equivalent of Section 56(2)(viib) in its new architecture. Section 92 of the 2025 Act comprehensively lists incomes chargeable under “Income from Other Sources”, and no clause therein taxes a company on receipt of share subscription above FMV. The omission is structural, not incidental.

VI. Existing Anti-Avoidance Checks: GAAR, Section 68, and FEMA

While the direct tax framework no longer taxes the company on receipt of share premium above FMV, it would be an overstatement to say that no legal check remains. Several provisions of general application continue to operate, and practitioners should be aware of both their scope and their limitations.

General Anti-Avoidance Rule (GAAR): GAAR permits the Revenue to disregard, recharacterise, or restructure an arrangement where the main purpose (or one of the main purposes) is to obtain a tax benefit, and the arrangement lacks commercial substance or is entered into in a manner not ordinarily employed for bona fide business purposes. In principle, GAAR could be invoked against a sham subscription arrangement designed to route unaccounted money into Co. A under the guise of a share premium. However, GAAR has important practical limitations: it requires approval of an Approving Panel, is prospective and discretionary, and has a high threshold of proof. It is not a surrogate for a specific anti-abuse provision of the type that Section 56(2)(viib) provided.

Unexplained Cash Credits: Section 68 of the 1961 Act (and its equivalent in the 2025 Act) empowers the Assessing Officer to treat as income of the company any sum found credited in its books, where the company fails to satisfactorily explain the nature and source of the credit. For share subscriptions, Section 68 requires the company to establish (a) the identity of the investor, (b) the creditworthiness of the investor to make the investment, and (c) the genuineness of the transaction. In money laundering scenarios, investors are often shell entities with no demonstrable economic capacity, and Section 68 can be a powerful tool. However, Section 68 addresses the source of the investment, not the pricing of the shares. A creditworthy investor paying a hefty premium presents no Section 68 issue on the source side, even if the economic rationale for the premium is dubious.

FEMA and RBI Pricing Guidelines: Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, issuances of shares to non-residents are subject to pricing guidelines that set a floor i.e. the price cannot be below FMV. There is no ceiling under FEMA for inbound investment. Accordingly, a foreign investor subscribing to shares at above FMV does not violate FEMA, and no FEMA consequence flows from the mere overvaluation. For resident-to-resident transactions, FEMA has no application.

The composite picture is that while GAAR, Section 68, and FEMA collectively provide a backdrop of regulatory oversight, none of them offer the targeted, automatic, quantifiable tax consequence that Section 56(2)(viib) had provided for over a decade. The anti-abuse toolkit has been weakened, and the gap is real.

VII. Implications for Sham Transactions and the Litigation Landscape

The opening that the sunset of Section 56(2)(viib) creates is, for legitimate businesses and genuine investors, an entirely welcome development, which is that it removes a source of valuation disputes, litigation, and investment friction that had bedevilled the startup ecosystem for twelve years. The Government’s policy objective of promoting domestic and foreign investment in early-stage companies is well-served by the change.

However, the same opening presents an obvious opportunity for structured abuse. The classic model i.e. routing unaccounted cash into a business through an inflated share subscription now has no direct tax consequence. A person holding unaccounted income needs only to arrange for a co-operative subscriber to invest at an above FMV price. The company receives the money as share capital and premium, no income accrues to any party under the income-tax law and the money is effectively laundered into the legitimate economy. The investor’s cost of acquisition of the shares is recorded at the inflated price, creating a large capital loss on eventual exit. This is a cost that willing participants in a sham arrangement may be perfectly prepared to absorb.

The Revenue is not without recourse since GAAR and Section 68 will be deployed but both provisions require fact-specific inquiry, depend on documentary evidence, and are susceptible to litigation on procedural as well as substantive grounds. Taxpayers who are determined to exploit the gap will find it fertile ground for at least the period needed to challenge any Revenue action through the appellate hierarchy.

The result is likely to be a surge in litigation of a different character from what Section 56(2)(viib) generated. Previously, the dispute was about valuation and now, the dispute will be about characterisation, is this transaction genuine? Questions related to genuineness are inherently more fact-intensive, more difficult to resolve at the assessment stage, and more likely to travel through the Commissioner of Income-tax (Appeals), the Income Tax Appellate Tribunal, and the High Courts over extended periods.

VIII. Conclusion

The sunset of Section 56(2)(viib) of the Income-tax Act, 1961, effective 1st April 2025, is in principle a sound and long-overdue policy correction. The provision had outlasted its usefulness as an anti-abuse tool and had become, in practice, a recurring source of unjust harassment for legitimate startups and their investors.

However, the manner of its removal, without stated reasons in the Finance Act Memorandum, without a targeted replacement provision, and without any consequential amendment to the general anti-avoidance framework has created a structural gap in the taxation of share premiums above FMV. Section 92(2)(m) of the Income-tax Act, 2025, the surviving counterpart provision, operates only in the opposite direction: it taxes underpriced receipts in the hands of the recipient, not overpriced subscriptions in the hands of the company.

The net result is that an investor who pays ₹1,000 for shares with an FMV of ₹10, i.e. a premium of ₹990 per share, triggers no income-tax consequences for either the company or the investor. While GAAR, Section 68, and FEMA provide a degree of regulatory backstop, none of them offer the automatic and targeted protection that the deleted provision once did.

The Government has, in effect, chosen to trust the market and the general anti-avoidance framework to police this space. Whether that trust proves warranted or whether the space is exploited for structured abuse, generating a new generation of litigation that replaces the valuation disputes of the past twelve years with characterisation disputes, will depend on the vigilance of tax administration and the alacrity with which courts develop the jurisprudence under GAAR in this specific context.

For practitioners, the immediate takeaways are clear: maintain robust documentation for every share subscription at above-FMV pricing, be prepared to demonstrate the commercial rationale for any premium and treat the GAAR threshold not as a comfortable distant horizon, but as a genuine and present risk in any arrangement where the economic substance of an above-FMV subscription is not self-evident.

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This article is intended for academic and informational purposes only and does not constitute legal or tax advice. Readers are advised to consult qualified professional advisors for guidance on their specific circumstances.