ISO Certified Premium Startup Consultancy Company
ISO Certified Premium Startup Consultancy Company
Startups in India face numerous challenges, one of which is raising funds. When startups issue equity or other securities to investors, they often do so at a valuation that is higher than the company's current fair market value. This valuation step-up can create tax implications for both the company and its investors. In this blog, we will explore the tax exemption on investments above fair market value in India and how it can benefit startups.
Under Indian tax laws, investments in startups can be subject to tax liability if the investment is made at a valuation above fair market value. This is because the Income Tax Act requires that all property transfers be taxed at fair market value. If a startup issues shares to an investor at a valuation higher than the fair market value, the investor will be taxed on the valuation markup. This means that the investor will pay tax on a gain that they have not yet realized.
The same is true for the startup. If the startup issues shares at a valuation above fair market value, it will be subject to tax on the value of the markup. This can create a significant tax liability for the company, which can be detrimental to its financial health.
Fortunately, there are certain exemptions to the fair market value rule that allows for tax-free treatment of investments made in startups. These exemptions are designed to encourage investment in startups and support their growth and development.
One such exemption is Section 56(2)(viib) of the Income Tax Act. This exemption provides that if a private company issues shares to a resident individual or a domestic company at a price that exceeds the fair market value, the excess amount is not treated as income. This exemption applies only to investments made by resident individuals or domestic companies in a startup that meets certain criteria.
To qualify for the Section 56(2)(viib) exemption, the startup must meet certain conditions. These include:
The startup must be incorporated as a private limited company or a limited liability partnership after April 1, 2016, but before April 1, 2021.
The turnover of the startup must not exceed Rs. 25 crores in the financial year preceding the year in which the shares are issued.
The startup must be engaged in an eligible business, which includes technology or innovation-driven businesses, and should not be engaged in any of the prohibited businesses listed in the notification.
The startup should have received approval from the Department of Industrial Policy and Promotion (DIPP) for availing of the exemption.
If a startup meets these criteria, it can issue shares at a price that exceeds the fair market value without attracting any tax liability under Section 56(2)(viib) of the Income Tax Act.
The tax exemption on investments above fair market value provides several benefits for startups. First and foremost, it encourages investment in startups by reducing the tax liability for both the company and its investors. This can make it easier for startups to raise funds and support their growth and development.
Secondly, the tax exemption on investments above fair market value can help startups to attract and retain top talent. By granting equity awards at a higher valuation than the fair market value, startups can offer employees and consultants a valuable form of compensation that is not subject to tax liability.
Thirdly, the tax exemption on investments above fair market value can also help startups to increase their valuations. By issuing shares at a higher valuation than the fair market value, startups can raise more capital without diluting the ownership of existing shareholders. This can help to increase the perceived value of the company and make it more attractive to future investors.
Finally, the tax exemption on investments above fair market value can also help startups to remain competitive with larger, more established companies. By offering tax benefits that are not available to larger companies, startups can level the playing field and attract investors who might otherwise be inclined to invest in larger, more established companies.
The tax exemption on investments above fair market value is a valuable tool for startups and early-stage companies that are looking to raise funds and support their growth and development. By providing a tax benefit for investors and companies, these exemptions can encourage investment in startups and help them to remain competitive with larger, more established companies.
However, it's important to note that the tax treatment of investments in startups and early-stage companies can be complex, and it's important to consult with a tax professional to understand the potential tax implications of such investments. At Neusource Startup Minds India Ltd., we provide comprehensive tax advisory and compliance services to help startups and early-stage companies navigate the complex tax landscape and maximize their tax benefits. Contact us today to learn more.
16 Jun
To start a new business is easy, but to make it successful is difficult . So For success, choose the best." Be compliant and proactive from the beginning and choose NEUSOURCE as your guidance partner.
