पाठशाला Pathshala · नियम Niyam, Law and compliance · Lesson 16 · Build

Angel tax after its abolition, and the valuation reports still required

Section 56(2)(viib) no longer taxes a startup on premium above fair value. The valuation reports did not retire with it: FEMA still sets a floor for foreign money and income tax still watches the buyer.

Pathshala, The Founder Library · 11 October 2026 · 7 min read

Modern glass towers in Bengaluru against a clear blue sky. — Photograph: Aditya Oberai · Pexels

For twelve years an Indian startup that raised money at a price above what a tax officer thought it was worth could be taxed on the difference as if the premium were profit. That rule, angel tax, has gone. Founders who hear only that sentence stop commissioning valuations, and then find that a foreign investor’s bank will not process the remittance without one.

This lesson sets out what angel tax was and what its removal changed, then the three tests that still apply to a share issue: the income-tax valuation under Rule 11UA, now aimed at the buyer; the FEMA pricing guideline for any money from outside India; and the old question of whether the money is explained at all. A figure tests one price against all three. Facts were checked against the Ministry of Finance, the Income Tax Department and the Reserve Bank on 10 October 2026.

What angel tax was

Section 56(2)(viib) of the Income-tax Act 1961, introduced in 2012, taxed a closely held company on the share premium it received above the fair market value of the shares. A company that issued shares at ₹1,000 when the tax valuation said ₹400 was treated as earning ₹600 a share of income. The fair market value came from Rule 11UA, which by the end offered a menu of methods: net asset value, discounted free cash flow by a merchant banker, the price paid by a venture capital fund, and for non-resident investors comparable company multiples, probability-weighted expected return, option pricing, milestone analysis and replacement cost, with a 10 per cent tolerance. The provision was extended to non-resident investors shortly before it was removed.

What the abolition changed

The Union Budget of 23 July 2024 abolished angel tax for all classes of investors. The Finance (No. 2) Act 2024 did it by a single sentence: the clause shall not apply from assessment year 2025–26, that is, to shares issued from 1 April 2024. The Income-tax Act 2025, in force since 1 April 2026, did not alter the underlying policy.

So a company issuing shares today is not taxed on the premium, whoever the investor is and whatever the valuation. A founder no longer needs a valuation designed to defend a high price to a tax officer. What a founder still needs is the right valuation for each of three other readers, and the three are not looking for the same thing.

It helps to name them. The income-tax officer reads the price from below and asks whether anyone received shares for less than they were worth; the document is a Rule 11UA computation. The Reserve Bank reads the price against a floor and asks whether a non-resident paid at least fair value; the document is a fair value certificate from a chartered accountant, merchant banker or cost accountant. And the assessing officer under section 68 reads the money rather than the price and asks whether it can be explained; the document is the investor file. One round can need all three, and none substitutes for the others. A merchant banker’s discounted cash flow report that once defended a high price against angel tax now does a different job: it is evidence of fair value for the foreign exchange floor, and it should be dated for that purpose.

Valuation one: Rule 11UA, now aimed at the investor

Section 56(2)(x) of the 1961 Act, a policy the 2025 Act did not alter though it renumbered the section, taxes any person who receives property, including shares, for less than its fair market value: the shortfall is their income. The Lakshmikumaran and Sridharan analysis notes that it survives the abolition and bites where shares are issued below fair value. For shares of an unlisted company, fair market value for this purpose comes from Rule 11UA, whose general formula is a book-value calculation: assets, with specified adjustments, less liabilities, scaled to the paid-up value of the shares.

Silver coins resting on the pan of an antique weighing scale in a collection room. — The test has turned round. Income tax now asks whether a buyer paid too little, not whether the company was paid too much. Photograph: beytlik · Pexels

The direction has reversed. Angel tax punished a price that was too high; section 56(2)(x) punishes a price that is too low. In a priced round that is rarely a problem, because investors pay well above book value. It is a problem in the transactions founders treat as informal: shares allotted to a friend at face value after the company has built up assets, a co-founder’s shares moving to a new co-founder at par, a sweat-equity top-up that was never valued. A company that has raised ₹30 crore and still holds most of it has net assets near ₹30 crore; with ten lakh shares its book value is near ₹300 a share, and allotting twenty thousand shares to an adviser at ₹10 hands them about ₹58 lakh of taxable income they did not expect.

Valuation two: FEMA pricing for foreign money

Any money from a person resident outside India brings in the foreign exchange rules, and those set a price floor that has nothing to do with angel tax. Under the Reserve Bank’s Master Direction on Foreign Investment, updated to 15 June 2026, an unlisted company may not issue equity instruments to a non-resident at a price below their fair value, worked out under an internationally accepted pricing methodology on an arm’s length basis and certified by a chartered accountant, a SEBI-registered merchant banker or a practising cost accountant. The same floor applies when a resident sells shares to a non-resident; when a non-resident sells to a resident, the fair value is a ceiling. For convertible instruments the conversion price or formula must be fixed upfront and cannot be below fair value at the time of issue. The certificate must be no more than ninety days old on the date of the investment.

Take a seed round with a Singapore fund at ₹1,200 a share. The merchant banker’s certificate, dated seventy days before the expected closing, puts fair value at ₹1,100, so the price clears the floor. Then the closing slips by a month. On the day the money arrives the certificate is a hundred days old and no longer valid for the investment, and the company needs a fresh one, possibly at a different number, before the round can be reported cleanly. Time the certificate to the realistic closing date, not the optimistic one.

Keep the certificate with the round papers, because the reporting that follows rests on it. A round that closes without a current certificate is a contravention to be regularised later, often by compounding, and the cost of that exceeds the valuer’s fee many times over. The [FEMA lesson](/library/fema-for-founders-when-a-foreigner-invests) covers the reporting that follows.

Section 68 and the questions that did not go away

Angel tax was about price. Section 68 is about whether the money is explained at all. An assessing officer can treat a sum credited in the books, including share capital and premium, as income where the company cannot explain its nature and source to the officer’s satisfaction, and such income is taxed at 60 per cent plus surcharge and penalties. The abolition did not touch this, and the same analysis warns that it is the provision officers will use where an investor’s identity or creditworthiness is in doubt.

The defence is a file, not a valuation. For every investor: identity documents and PAN or the foreign equivalent, the bank statement showing the money left their account, and evidence that they could afford it, such as a return or a fund’s audited accounts. A seed round from twelve angels needs twelve such files. Build them while the angels are still excited to hear from you.

Angel tax asked whether the price was too high. Its successors ask whether the price is too low and whether the money can be explained.

Before every round closes

Four weeks before a round is expected to close, list every instrument and every investor and mark which are resident and which are not. If any are non-resident, commission a fair value certificate from a chartered accountant or merchant banker, timed to be under ninety days old on the day the money arrives, and agree the conversion terms of any convertible against it. Compute the Rule 11UA value from the latest balance sheet, and check that no allotment in the round, including to advisers or employees outside the ESOP, is priced below it. Build the section 68 file for each investor. Keep all three documents together with the board resolution. And after every round, ask the chartered accountant to confirm in one line that nothing in the 2025 Act or its rules has changed the test.

Nothing here is legal or tax advice; confirm the current rule with a chartered accountant or lawyer before acting.