"We need a merchant banker valuation or the angel tax will kill us": What the Companies Act and Income Tax Act actually require now

"We need a merchant banker valuation or the angel tax will kill us": What the Companies Act and Income Tax Act actually require now

A founder closes a ₹4 crore seed round at a ₹40 crore post-money valuation. Their lawyer forwards a checklist item in bold red: "Obtain merchant banker valuation under Rule 11UA and file to avoid angel tax under Section 56(2)(viib)." The founder panics, spends ₹75,000 on a rushed DCF report, and worries for months that the Assessing Officer will treat the premium as taxable income. Almost none of that anxiety is warranted for a round raised today — because angel tax was abolished with effect from Assessment Year 2025-26. The problem is that the advice, the templates, and half the internet were written for a law that no longer applies to new investments, while a genuine risk still lingers for money raised in earlier years. Getting this distinction wrong costs founders money on valuations they no longer need, and lulls others into ignoring notices they still have to answer.

What the law actually requires

Angel tax lived in Section 56(2)(viib) of the Income Tax Act, 1961. It said that when a closely held company (which every private limited company is) issued shares to a resident at a price exceeding the fair market value (FMV) of those shares, the excess — the gap between issue price and FMV — was treated as "income from other sources" in the hands of the company and taxed at the applicable rate, historically up to roughly 30% plus surcharge and cess. It was designed to catch money laundering through inflated share premiums, but in practice it hit genuine startups whose valuations were driven by future potential rather than present net asset value.

The Finance Act, 2024 deleted Section 56(2)(viib) with effect from 1 April 2025, meaning it does not apply from Assessment Year 2025-26 onwards. For any share issue on or after 1 April 2024 (the relevant previous year for AY 2025-26), there is no angel tax. This applies to all investors — resident and non-resident, angel and institutional — and to all closely held companies, not just DPIIT-recognised startups. The earlier carve-outs, including the DPIIT exemption route and the requirement to file the Form 2 declaration with DPIIT, are no longer needed to defeat angel tax on a current round, because there is no charge left to defeat.

Two things did not change, and founders routinely conflate them with angel tax:

First, Section 56(2)(x) still exists. If a person receives shares (or other property) for less than FMV, or for no consideration, the recipient can be taxed on the shortfall. This is the mirror image of angel tax and is a live provision. It matters in transfers, gifts of shares, and sweat-equity-style arrangements — not in a normal priced funding round where investors pay a premium, not a discount.

Second, the Companies Act, 2013 valuation requirement survives untouched. Under Section 62(1)(c) read with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, any preferential allotment of shares by a private company must be made at a price justified by a valuation report from a registered valuer (registered with IBBI under Section 247). Similarly, Section 42 and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 govern private placement and also lean on a registered-valuer price. For shares issued to a non-resident, FEMA and the FDI pricing guidelines independently require the price to be not less than the fair value worked out per internationally accepted methodology, certified in the FC-GPR filing to the RBI within 30 days of allotment.

So the valuation you still need is a registered valuer report for Companies Act / FEMA compliance — not a merchant banker report to escape angel tax. The distinction is not academic: the professional, the methodology, and the purpose are different.

Practical implications

For a round raised today, the practical position is liberating. A startup can issue shares at any premium a willing investor agrees to, and there is no angel tax exposure on the premium. You do not file Form 2 with DPIIT for angel-tax purposes, you do not need a merchant banker's Rule 11UA(2) certificate for that purpose, and you do not have to defend a DCF against the Assessing Officer's preferred net-asset-value method. The old cat-and-mouse game between founders' forward-looking valuations and the AO's backward-looking book values is over for AY 2025-26 and later.

But three real consequences remain.

Legacy assessments are still open. If your company raised funds at a premium in FY 2022-23 or FY 2023-24 (AY 2023-24 / AY 2024-25), Section 56(2)(viib) applied in those years and the Assessing Officer can still issue a notice within the limitation window under Section 149 (broadly up to three years, and up to five years and three months for escaped income above ₹50 lakh). Abolition is prospective; it does not wipe out prior-year exposure. A notice under Section 148 for one of those years is not defeated by pointing at the 2024 amendment.

The Companies Act valuation failure has its own penalty. If you skip the registered valuer report on a preferential allotment, the allotment is defective under Section 62 / Section 42. A private placement default under Section 42(10) can attract a penalty that may extend to the amount raised or ₹2 crore, whichever is lower, and the company may be required to refund the money with interest. This penalty exists regardless of angel tax and is easy to trip over now that founders wrongly believe "no more valuation needed."

FEMA pricing breaches invite compounding. If a non-resident invests below fair value or the FC-GPR is filed late, the company faces a Late Submission Fee and potential compounding under FEMA — again, entirely separate from income tax. MCA21 v3 and the RBI's FIRMS portal both flag missing or delayed filings automatically, so an allotment that looks clean on the cap table can still be sitting on an open regulatory exception.

Step-by-step: what to do

• Date your round against 1 April 2024. Any share allotment with an allotment date in FY 2024-25 or later is outside Section 56(2)(viib). Confirm the date of allotment (board resolution / PAS-3), not the term-sheet date, because that is the operative date.
• Still commission a registered valuer report for any preferential allotment or private placement. Engage an IBBI-registered valuer under Section 247, not (only) a merchant banker. The report supports your Section 62(1)(c) / Rule 13 price and your FEMA fair-value certification.
• File PAS-3 (return of allotment) within 30 days of allotment under Section 39(4) and Rule 12. Late filing attracts a per-day penalty under Section 39(5)/450. For private placement, ensure the PAS-4 offer letter and PAS-5 record exist before money is received.
• For any foreign investor, file FC-GPR within 30 days on the RBI FIRMS portal, attaching the valuation certificate. Missing this is the single most common cross-border defect.
• Pull your FY 2022-23 and FY 2023-24 filings and check whether any premium round in those years was covered by a DPIIT exemption or a defensible valuation. If not, keep the valuation working papers ready in case a Section 148 notice arrives — do not assume abolition protects those years.
• Delete "angel tax" from your current fundraising checklist but keep "registered valuer report," "PAS-3," and "FC-GPR." Re-label the task so your team stops paying for the wrong certificate.

FAQ

Is angel tax completely gone?
For share issues on or after 1 April 2024 (AY 2025-26 onwards), yes — Section 56(2)(viib) is abolished and does not apply to any investor. Assessments for earlier years can still be reopened within the limitation period.

Do DPIIT-recognised startups still need the angel tax exemption?
No. The DPIIT exemption and the Form 2 declaration existed to escape Section 56(2)(viib). With the section gone, that specific exemption is redundant for new rounds. DPIIT recognition still matters for other benefits, such as the Section 80-IAC income tax holiday.

So I don't need any valuation now?
Wrong — this is the costly trap. You still need a registered valuer report under Section 62(1)(c) / Rule 13 for the Companies Act, and a fair-value certificate for FEMA if a non-resident invests. What you no longer need is a valuation whose sole purpose was defending against angel tax.

We raised at a high premium in FY 2023-24 and never took the DPIIT exemption. Are we safe?
Not automatically. That year is within the angel tax regime and within the reassessment window under Sections 148/149. Keep your valuation basis documented; if a notice comes, you defend on the FMV, not on the 2024 abolition.

Closing

Angel tax is gone for new rounds, but the valuation, allotment, and FEMA obligations that founders confused with it are very much alive — and now easier to overlook. For a compliance audit of your company, visit pvtltd.co.