Angel Tax and Share Premium: What Changed Under Section 56(2)(viib)

The starting point needs to be stated clearly, because a lot of outdated commentary still circulates: Section 56(2)(viib), commonly called the angel tax provision, was abolished for all classes of investors by the Finance (No. 2) Act, 2024, effective from FY 2024-25 (April 1, 2024). For FY 2026-27, it does not tax a closely held company merely because it issues shares at a premium above Fair Market Value - to a resident investor or a non-resident investor.

This corrects a common but wrong summary that says only the non-resident scope was removed while resident investors remain covered. The actual sequence was the opposite: Budget 2023 had extended angel tax to non-resident investors for the first time (it previously applied only to residents), which caused significant industry pushback. Budget 2024 then abolished the provision entirely, for every investor class, starting FY 2024-25.

How the Historical Provision Worked

Before its abolition, Section 56(2)(viib) broadly applied where a closely held company issued shares to an investor at a price exceeding the prescribed FMV. The excess over FMV could be treated as income of the company under "Income from Other Sources," subject to statutory exclusions and exemptions. A simplified historical example: if a company issued shares at Rs 200 per share and the applicable FMV was Rs 140, the Rs 60 excess per share could create tax exposure, subject to the law applicable for that year.

The provision was significant because seed-stage companies often raise capital based on future potential rather than current assets or profits. A company with low revenue could have a high negotiated valuation, creating tension between commercial fundraising terms and tax valuation rules - which is exactly why its abolition was welcomed across the startup ecosystem.

Why Historic Exposure Still Matters

Even though the provision no longer applies to new FY 2026-27 issues, founders should not ignore older rounds. Review is sensible if the company raised equity before April 1, 2024, claimed a DPIIT-related exemption in an earlier year, received an income tax notice or assessment query, used aggressive projections without adequate valuation support, or has incomplete investor and Board documentation from that period.

An investor conducting due diligence today may still ask whether any historic Section 56(2)(viib) exposure has been assessed, contested, settled, or provided for in the financial statements. A clean answer requires records, not recollection.

DPIIT Recognition and the Historical Exemption Route

Under the earlier angel tax exemption framework, an eligible DPIIT-recognised startup could make a declaration through Form 2 and satisfy prescribed conditions relating to aggregate paid-up share capital and share premium after the proposed issue. Because Section 56(2)(viib) has been abolished for new issues, this historical exemption route should not be presented as a current tax prerequisite for FY 2026-27 fundraising.

However, retain all historical declarations, recognition certificates, valuation reports, and investment documents from earlier funding rounds - these remain relevant to prior assessment years and investor diligence into the company's history.

Valuation Methods and Rule 11UA Context

Historically, Rule 11UA provided valuation rules and safe-harbour concepts for the angel tax provision. The methods commonly discussed were Net Asset Value (NAV), based largely on the company's balance sheet, and Discounted Cash Flow (DCF), which estimates future cash flows and discounts them to present value. NAV can be a poor commercial fit for an early-stage technology business whose value lies in intellectual property and growth prospects rather than current assets. DCF is often more aligned with startup financing, but only when projections are prepared honestly, assumptions are documented, and the model can withstand review. See our startup valuation guide for a fuller treatment of these methods and when each applies today.

Practical Funding Impact Today

For a new domestic or foreign angel or seed round in FY 2026-27, founders should not build the transaction around a current Section 56(2)(viib) tax risk - the provision has been abolished. Instead, focus on the issues that remain live: whether the valuation is credible to investors, whether rights attached to the shares are properly documented, whether the cap table and prior allotments reconcile, whether the company has met Companies Act approval and filing requirements, and whether FEMA pricing and reporting apply because any investor is non-resident.

A valuation report is not merely a compliance document that has become optional - it is the financial narrative that investors, auditors, and future buyers use to understand why the round was priced as it was.

Preserve a Defensible Valuation File

For each funding round, keep a file containing the term sheet, Board and shareholder approvals, valuation report, financial model, key assumptions, investor subscription documents, bank receipts, share allotment records, and ROC filings. If the company uses DCF, document the business drivers behind revenue growth, gross margin, hiring, customer acquisition, working capital, and terminal value. A spreadsheet without a written assumptions note is difficult to defend after the founding team has changed - or after a tax officer asks about a round raised years ago under the old provision.