The government provided a blanket exemption from angel tax to various structures such as pension and sovereign wealth funds, among others investing in India from 21 countries, but corporate entities were left out, making them potentially liable to the levy.
This could have unintended consequences for foreign direct investment (FDI), which fell 16% in FY23 after many years of robust growth, experts say.
Indian income tax authorities sent notices in March to headquarters of several hundreds of multinational companies (MNCs), asking them to explain the source and valuation of funds injected into their Indian arms in FY19.
With the latest change in the tax law and no special carveout for corporate overseas investment in unlisted subsidiaries, experts say that such tax queries would swell, undermining the ease of doing business.
“One unintended consequence of this amendment is that a parent MNC investing in its subsidiaries in India would also be subject to angel tax provisions,” said Sudhir Kapadia, partner, EY. “At a time when India is striving to attract increasing FDI, this aspect needs to be addressed post haste.”
A senior government official played down the concerns, saying these were “unfounded fears.” Valuation Norms
The official said the government had widened valuation norms.
Under Section 56(2)(vii)(b) of the Income Tax Act, if a closely held company issues shares at a price exceeding fair market value, computed in accordance with the prescribed methodology, the difference is to be taxed as income from other sources.
The tax largely impacts angel investments and is therefore called the angel tax.
In the February budget, the government amended Section 56(2) (viib), bringing all foreign investment under its ambit, against the earlier narrower provision that covered only non-resident Indians.
The measure seeks to prevent money laundering through inflated valuations.
“Foreign parents from white-listed jurisdictions who are not specified entities are re-evaluating their tax risks while investing in unlisted Indian subsidiaries, as they are not sure as to whether the valuation of Indian company under the rules would be acceptable to the Indian authorities or can the same may be questioned,” said Amit Agarwal, partner, Nangia & Co LLP.
21-Nation Exemption
The Central Board of Direct Taxes (CBDT) Thursday issued a notification exempting foreign central banks, pension funds, sovereign wealth funds and endowment funds from 21 countries from the angel tax levy.
These 21 countries are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US.
The notification was silent on the tax treatment of corporate structures. Investors from Mauritius, Singapore and Luxembourg were excluded.
Those entities not covered by the carve-out will also get flexibility in determining fair market value for determining if angel tax should be levied.
Five more methods for valuation by a merchant banker have been proposed.
“Original intent to prevent laundering of black money via investments (and taxing the excess premium) can be addressed by making a positive list of cases to be covered under GAAR (General Anti-Avoidance Rule) regime, rather than covering everyone with a negative list of carve-outs,” according to Bhavin Shah, partner and deals leader, PwC India.
“Indian startups and subsidiaries of large multinational companies will spend a lot of time and energy to justify the commercial pricing of a transaction to tax officers, even where there is no black money involved. It’s like punishing the entire class for mischief by one student in the class,” he said.
There are several instances of bona fide FDI investments that will have to grapple with the rules that tax capital inflows, even where the source of funds is legitimate, said Gouri Puri, partner at Shardul Amarchand Mangaldas & Co. These include joint ventures where the share price is often commercially negotiated beyond fair value considerations among the joint venture partners or cases of investment by an MNC group in its operating company.
“This will mean that they will have to keep justifying the fair value of the shares each time they capitalise the Indian entity,” Puri said. “This may hamper ease of doing business in India.”
