Under Section 56(2)(viib) of the Income Tax Act, any excess premium received by a closely held company on issuing shares—where the consideration exceeds both the face value and fair market value—is chargeable to tax under the head “Income from Other Sources.” This applies whether the consideration is received from a resident or non-resident. However, the provision does not apply to venture capital undertakings receiving funds from a venture capital company, venture capital fund, or Category I or II Alternative Investment Fund (AIF). Similarly, start-ups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) are exempt if they meet prescribed conditions.
A DPIIT-recognized start-up can claim exemption from this provision if the aggregate paid-up share capital and share premium, after the issue, do not exceed ₹25 crores. For this calculation, investments from non-residents, venture capital entities, and listed companies with net worth exceeding ₹100 crores or turnover above ₹250 crores are excluded. To retain the exemption, the start-up must not invest, for seven years, in specified assets such as residential or commercial property (except for business use or rental), loans and advances, shares or securities, capital contributions to other entities, high-value vehicles, jewellery, or art. To claim the exemption, the start-up must file a declaration in Form 2 with the DPIIT, which then forwards it to the CBDT for approval. If the conditions are violated, the premium amount exceeding the fair market value becomes taxable in the year of violation and is treated as underreported income, attracting penalties under Section 270A.
The fair market value (FMV) of shares is determined using either the book value method or the Discounted Cash Flow (DCF) method prescribed under Rule 11UA—whichever is higher. Alternatively, the company may substantiate a higher value to the Assessing Officer based on its tangible and intangible assets, such as goodwill, patents, or trademarks. For unquoted equity shares, FMV is computed using the audited balance sheet on the valuation date, excluding certain items like prepaid taxes and unascertained liabilities. In the case of other unquoted securities, valuation must be supported by a report from a merchant banker or accountant. The DCF method, in particular, determines the present value of a business based on its projected future cash flows discounted at an appropriate rate.
This provision aimed to prevent the misuse of share premium receipts for tax evasion in private companies. However, it has been made inapplicable from Assessment Year 2025–26, aligning with the government’s measures to promote start-ups and ease of doing business.
Taxability of excess consideration received on shares issued at a premium (Not Applicable w.e.f. AY 2025-26)
- Any excess premium received by a company is chargeable to tax under the head income from other sources if the following conditions are satisfied:
(a) Shares (equity or preference shares) are issued by a closely held company;
(b) The consideration for the issue of shares is received from any person (resident or nonresident);
(c) The consideration received for the issue of shares exceeds the face value and fair market value of shares.
- If the above conditions are satisfied, the consideration received exceeding the fair market value of the share shall be taxable in the hands of the issuer company.
- A closely held company is a company in which the public is not substantially interested. In the following cases, this provision shall not apply:
(a) The consideration is received by a Venture Capital Undertaking from a Venture Capital Company, Venture Capital Fund, Category-I or Category-II Alternative Investment Fund (AIF); or
(b) The company is an eligible start-up fulfilling conditions as prescribed in Notification No. GSR 127 (E) [F.NO.5 (4)/2018-SI], Dated 19-2-2019.
Exemption to a start-up company
- A start-up recognised by DPIIT gets immunity from the provisions of Section 56(2)(viib) if it fulfils the conditions specified below.
- The aggregate amount of paid-up share capital and share premium of the start-up, after the issue or proposed issue of shares, should not exceed Rs. 25 crores. While calculating this threshold limit, the issue of shares to the following persons shall not be included:
(a) A non-resident person;
(b) Venture Capital Company;
(c) Venture Capital Fund; and
(d) A company whose shares are frequently traded within the meaning of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and whose net worth exceeds Rs. 100 crore or turnover exceeds Rs. 250 crores for the financial year preceding the year in which shares are issued.
- The eligible start-up should not invest in any of the following assets for a period of 7 years from the end of the latest financial year in which the shares are issued at a premium:
(a) Land or building, being a residential house, other than that used for the purposes of renting or held as stock-in-trade in the ordinary course of business;
(b) Land or building, not being a residential house, other than that occupied by the startup for its business or renting purposes or held as stock-in-trade in the ordinary course of business;
(c) Loans and advances if the start-up is not engaged in the ordinary business of lending money;
(d) Capital contributions to any other entity;
(e) Shares and securities;
(f) Motor vehicle, aircraft, yacht or any other mode of transport, if the cost of such an asset exceeds Rs. 10 lakhs other than that held by the Start-up for the purpose of plying, hiring, leasing or as stock-in-trade in the ordinary course of business;
(g) Jewellery held otherwise than as stock in trade; and
(h) Archaeological collections, drawings, paintings, sculptures, any work of art or bullion.
- To claim this exemption, the start-up has to file a declaration in Form 2 with the DPIIT along with the details of the company.
- The DPIIT shall forward the self-declaration form to the CBDT for approval. On successful submission of a self-declaration form, the start-up can issue the shares. The CBDT, thereafter, shall assess the application, and it can either accept it or reject it after giving it an opportunity of being heard.
- In case of failure to comply with these conditions, the consideration received from the issue of shares as exceeding the fair market value of such shares shall be deemed to be the income of the company chargeable to tax for the previous year in which such failure takes place.
- When the exemption is withdrawn, it shall be deemed that the company has underreported the income as a consequence of the misreporting, and a penalty shall be levied as per Section 270A.
Computation of the fair market value
- The fair market value of the shares shall be the higher of the following:
(a) Value determined in accordance with the book value method or DCF method prescribed in Rule 11UA; or
(b) Value substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature on the date of issue of shares.
- The Discounted Cash Flow (DCF) methodology expresses the present value of a business as a function of its future cash earnings capacity. In this method, future cash flows of a business are discounted at an appropriate discount rate on a going concern assumption.
- The book value of the unquoted equity shares shall be determined in accordance with the following formula:
- The book value of assets shall not include the following:
(a) Amount of prepaid taxes, as reduced by the amount of Income-tax refund claimed;
(b) Any amount shown in the balance sheet as an asset, including the unamortised amount of deferred expenditure, which does not represent the value of any asset;
- The book value of assets in the balance sheet shall be determined as per the following:
(a) The price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;
(b) The value of shares and securities as determined in the manner provided in this Rule 11UA;
(c) The value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property.
- The book value of liabilities shall not include the following:
(a) Paid up capital in respect of equity shares;
(b) Amount set aside for payment of dividends on preference shares and equity shares if such dividends have not been declared (before the date of transfer) at a general body meeting of the company;
(c) Reserves and surplus (even if the resulting figure is negative) other than those set apart towards depreciation;
(d) Excess provision for tax (including deferred tax liability);
(e) Provisions for unascertained liabilities;
(f) Contingent Liabilities.
- For the purposes of determination of the fair market value of unquoted shares for Section 56(2)(viib), the balance sheet of the closely held company shall mean the balance sheet (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor of the company appointed under the law relating to companies in force. Where the balance sheet on the valuation date is not drawn up, the balance sheet drawn up as on a date immediately preceding the valuation date, which has been approved and adopted in the annual general meeting of the shareholders of the company.
- The fair market value of unquoted shares and securities (other than equity shares) in a company shall be estimated to be the price it would fetch if sold in the open market on the valuation date, and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation.
MCQs on Taxability of excess consideration received on shares issued at a premium
Q1. Any excess premium received on the issuance of shares is chargeable to tax under the head income from other sources if such shares are issued by a______ .
Ans:- (a) Public Company
(b) Private Company
(c) Closely held company
(d) Every company
Correct answer: (c)
Explanation: Any excess premium received by a company is chargeable to tax under the head income from other sources if the Shares (equity or preference shares) are issued by a closely held company.
Q2. Any excess premium received on the issue of shares is chargeable to tax if the consideration for such shares is received from a___________
Ans:- (a) Resident Individual
(b) Non-resident Individual
(c) Domestic Company
(d) All of the above
Correct answer: (d)
Explanation: Any excess premium received by a company is chargeable to tax under the head income from other sources if the consideration for the issue of shares is received from any person (resident or non-resident);
Q3. In which of the following cases, provisions of section 56(2)(viib) are not applicable?
Ans:- (a) Where the company is an eligible start-up
(b) Where consideration received by a Venture Capital Undertaking from a Venture Capital Company
(c) Where consideration received by a Venture Capital Undertaking from a Category-I or Category-II AIF
(d) All of the above
Correct answer: (d)
Explanation: Section 56(2)(viib) shall not apply where:
(a) The consideration is received by a Venture Capital Undertaking from a Venture Capital Company, Venture Capital Fund, Category-I or Category-II Alternative Investment Fund (AIF); or
(b) The company is an eligible start-up fulfilling conditions as prescribed in Notification No. GSR 127 (E) [F.NO.5 (4)/2018-SI], Dated 19-2-2019.
Q4. The aggregate amount of paid-up share capital and share premium of the eligible start-up, after the issue or proposed issue of shares, should not exceed______ .
Ans:- (a) 10 crores
(b) 25 crores
(c) 50 crores
(d) 100 crores
Correct answer: (b)
Explanation: The aggregate amount of paid-up share capital and share premium of the startup, after the issue or proposed issue of shares, should not exceed Rs. 25 crores.
Q5. To claim the exemption under section 56(2)(viib), the eligible start-up has to file a declaration in________ with the DPIIT along with the details of the company.
Ans:- (a) Form 1
(b) Form 2
(c) Form 3
(d) Form 4
Correct answer: (b)
Explanation: To claim the exemption under section 56(2)(viib), the start-up has to file a declaration in Form 2 with the DPIIT along with the details of the company.
Q6. The Discounted Cash Flow (DCF) methodology expresses the_________ of a business as a function of its future cash earnings capacity.
Ans:- (a) Present Value
(b) Book Value
(c) Either (a) or (b)
(d) None of the above
Correct answer: (a)
Explanation: The Discounted Cash Flow (DCF) methodology expresses the present value of a business as a function of its future cash earnings capacity. In this method, future cash flows of a business are discounted at an appropriate discount rate on a going concern assumption.
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