2. Is Your Company A Startup?
Start-up India Action Plan
•Incorporated as a Private Limited Company, a Registered
Partnership Firm or a Limited Liability Partnership
•Period of existence and operations should not be exceeding 10
years from the date of incorporation
•Should have an annual turnover not exceeding INR 100 crore for
any of the financial years since its incorporation
•Entity should not have been formed by splitting up or reconstructing
an already existing business
•Should work towards development or improvement of a product,
process or service and/or have scalable business model with
high potential for creation of wealth & employment
Income Tax Act, 1961
•Incorporated/ registered as Private Limited Company/ Limited
Liability Partnership
•Incorporation: April 1, 2016 – April 1, 2021
•Annual turnover < INR 100 crores in the previous year relevant
to the assessment year for which tax holiday is claimed
•Working towards innovation, development or improvement of
products or processes or services, or should be a scalable
business model with a high potential of employment generation
or wealth creation
•Holds certificate from the Inter-Ministerial Board (IMB) as constituted
by the Department of Industrial Policy and Promotion (DIPP)
•Subject to certain reconstruction provisions
4. Proposed Relaxation for Start-ups in Budget 2020-21
India Budget for Fiscal Year 2020-21 proposes to rationalize the taxation on the profits of eligible start-up companies in
India with effect from April 1, 2020. In addition, the budget also proposes to relax and defer the taxation of ESOP
perquisites in the hands of employees of such start-up companies.
For Start-up Companies For Employees of Start-ups
Proposed in Budget 2020
• 100% tax holiday for 3 years
consecutively out of 10 years
only for "eligible" Start-ups
• To be eligible Start-up, turnover
shall not exceed INR 1 Billion in
the financial year for which tax
holiday is to be claimed
Earlier Provisions
• Only 7 financial years were
provided to claim tax holiday for
3 consecutive years;
• Turnover was earlier limited to
INR 0.25 Billion only
Proposed in Budget 2020
Tax on perquisite in the case of ESOPs
(ie tax on difference between FMV and
exercise price) is deferred to the earliest
of following dates:
a) Expiry of 5 years from relevant AY;
b) Date of sale of such securities; or
c) Date of termination of employment
Implications of the above
Start-ups employers would withhold tax
under Section 192 on such perquisites
only on the above deferred dates, and
not in the year of exercising ESOPs by
the employees
5. Key Insights
Amendments proposed for Start-up Companies
• Intent of the amendment is to incentivise start-ups in India by extending tax holiday benefits under Section 80-IAC and
keeping the same in line with the Notification of DPIIT dated February 19, 2019
• However, the benefit under Section 80-IAC (100 percent tax holiday) is available only for eligible start-ups as defined
in the Explanation (ii) to the Section 80-IAC of the IT Act
• An eligible start-up is a company or LLP which, fulfils certain prescribed conditions. These proposed amended
conditions (post Finance Bill 2020) are enlisted below:
1. Start-ups incorporated on or after April 1, 2016 but before April 1, 2021;
2. Turnover limit of INR 1 billion in the first year of claiming such tax holiday benefit; and
3. Certificate of eligible business as granted by Inter-Ministerial Board of Certification
In reality, start-ups are loss-making in the initial 5-7 years as they are chasing growth. Hence, a longer window of 10
years for availing tax holiday benefits vis-à-vis shorter time frame of 7 years previously, is a welcome move. A
clarification is needed that the clients/ customers of start-ups would not be required to deduct tax at source on
payments to be made to such start-ups. This would mean savings in terms of cashflows that today gets blocked as
TDS for 18-24 months. Also, by exempting profits from tax, the start-ups may perhaps not be eligible to carry forward
any tax losses made during the tax holiday period - thus, tax losses arising in the said period may not be available for
set-off against profits made in the future. Some clarity is required on this aspect as well. Minimum Alternate Tax
(MAT)/ Alternate Minimum Tax (AMT)* provisions continue to apply - rate of 18.5 percent on book profits, along with
applicable surcharge and cess (in case of profit-making ventures)
6. Key Insights (Cont.)
Amendments proposed for Employees of Start-up Companies
• The main aim of deferring the taxability event in case of ESOPs is to ease the burden of payment of taxes by the
employees and TDS compliances under Section 192 of the IT Act by such eligible start-up employer
• Therefore, two noteworthy consideration in relation to the proposed amendment are enumerated hereunder:
– Employees of "eligible" start-up companies only covered under Section 80-IAC of the Act would be entitled to the
benefit of this amendment
– Benefit of deferred taxable event would be available on options exercised on or after April 1, 2020 by the
employees of such eligible start-ups
• Deferral of such taxability event for employees of eligible start-ups would definitely assist in unlocking cash flows for
such employees
The Inter-Ministerial Board of Certification has approved and granted certificate to 260 start-ups (Refer Annexure) till
December 18, 2019 (40th Meeting), while there are 27,968 start-ups recognised by DPIIT. Thus, only 1 percent of start-ups
recognised by DPIIT are "eligible" for availing income tax related benefits, including tax holiday under Section 80-IAC and
deferred perquisite taxation proposed in the Finance Bill 2020. A list of eligible start-ups as approved by Inter-Ministerial
Board of Certification is provided as an Annexure. Further, the Memorandum to Finance Budget 2020-21 contradicts the
existing provisions of the IT Act. This anomaly is with regard to the year for which turnover is restricted to INR 1 Billion
(second condition in the definition of eligible start-up) as below:
– Income-tax Act: Turnover - in the previous year relevant to the assessment year for which deduction is claimed
– Memorandum: Turnover - in any of the previous years beginning from the year in which it is incorporated
8. Understanding the Context
• Section 56(2)(viib) of the IT Act also widely known as Angel Tax, has
been one of the leading controversial issue since its inception vide the
Finance Act, 2012
• Aims to tax excess premium received by a private company over Fair
Market Value ("FMV") upon the issue of shares
• Ultimately, such excess premium is deemed to be an income and
therefore is liable to tax in the hands of such private company under
section 56(2)(viib) of the IT Act
• Venture Capitalists are one of the major source of funding for new and
upcoming closely held (private) companies in India but Section
56(2)(viib) of the Act has been lurking around as a backdrop to it
9. Section 56(2)(viib) and its applicability
Provisions of
Section 56(2)(viib)
Any consideration for issue of shares
received by private company that exceeds
the face value of such shares, the
aggregate consideration received as
exceeds the FMV of such shares shall be
taxable under Section 56(2)(viib) of the IT
Act
[ if Sale Price > Face Value then,
Sale Price – FMV = Excess consideration taxable ]
FMV of shares of both listed and unlisted private
companies shall be determined as per the methods
prescribed in Rule 11U and 11UA of the Income-tax
Rules
All private companies in India, receiving consideration for issue
of shares from a resident comes under the purview of Section
56(2)(viib) of the IT Act. However, there are two exceptions
where the consideration is received by – (a) By a venture
capital undertaking from venture capital company or fund (b) By
company from a class of persons notified by Central Govt
CBDT Notification dated March 5, 2019 exempted the
start-up private companies from the provisions of Section
56(2)(viib) of the IT Act provided such companies shall
fulfil the conditions as specified in the DPIIT notification
dated February 19, 2019
Determination of FMV of shares and taxability of excess
premium under Section 56(2)(viib) has been a long litigated
matter between the companies and Indian tax authorities.
Profuse judicial precedents by various Tribunals and High
Courts in India have been shedding light on this issue
10. History of Section 56(2)(viib)
Provisions of Section
56(2)(viib) along with
Rules 11U and 11UA
were enacted into law
by the Finance Act
2012, with effect from
AY 2013-14
Introduction of Angel Tax
CBDT Notification dated
May 24, 2018
Section 56(2)(viib) is not
applicable if consideration
received from an investor
in accordance with the
approval granted by the
Inter-Ministerial Board of
Certification
2012
2018
2019
CBDT Notification dated
January 31, 2019
CBDT amended its 2018
notification, wherein the
approval was required to
be granted by CBDT and
not Inter-Ministerial
Board of Certification
CBDT Notification dated
March 5, 2019
CBDT exempted start-up
private companies from Section
56(2)(viib) provided such
companies fulfil conditions as
specified in the DPIIT
Notification dated February 19,
2019
CBDT Circular dated
August 30, 2019
CBDT issued a circular for
income tax assessment of
start-up private companies,
wherein it directed that
scrutiny with respect to
adjustments under Section
56(2)(viib) shall not be
pursued
12. Can the Tax officer compare revenues/ profits projected under DCF method vis-à-vis
actual revenue/ profit of the company and reject the valuation report?
Vodafone M-Pesa Ltd
Vs
DCIT
Mumbai Tribunal
• The AO/ CIT(A) had evaluated the accuracy of valuation at the time of assessment, ie comparing the
projections with the actual performance after the date of valuation report of the company
• The Hon'ble Tribunal held that the valuation of shares or for that matter any valuation in itself is a
projection of future events or activities and no doubt it has to be done with some accuracy, however no
person in the world at the time of projecting events or result, is expected to project with 100% of
accuracy and actual events are highly volatile and highly dependent on so many factors
A. Judgements favourable to Assessee
Bangalore Tribunal
Innoviti Payment Solutions
Pvt Ltd
Vs
ITO
• This ruling is positive in as much as it clarifies that for scrutinizing the valuation report, the facts and data
available on the date of valuation only has to be considered and actual result of future cannot be a basis
to decide about reliability of the projections
• Another important aspect is that the Tribunal held that it is the primary onus of the assessee to satisfy
about the "correctness" of the projections, discounting factor and terminal value etc with the help of
empirical data or industry norm if any and/or scientific data, scientific method, scientific study and
applicable guidelines regarding DCF method of valuation
Jaipur Tribunal
Rameshwaram Strong
Glass (P) Ltd
Vs
ITO
• DCF Method, is essentially based on the projections (estimations) and hence these projections cannot
be compared with the actuals to expect the same figures as were projected
• The Hon’ble Tribunal held that when the law has specifically provided a method of valuation and the
assessee exercised an option by choosing a particular method, changing the method or adopting a
different method would be beyond the powers of the Revenue Authorities
13. TUV Rheinland NIFE
Academy Pvt Ltd
Vs
ITO
Bangalore Tribunal
• The Hon’ble Tribunal considered the AO’s finding that the projections taken in the valuation were a long
way away from the actual figures
• It held that unless and until the assessee produces the evidences to substantiate the basis of projections
in cash flow and provides reasonable connectivity between those projections in cash flow with the reality
evidences by the material, it is not possible even for the Departmental Valuation Officer to conduct any
exercise of verification of the acceptability of the value determined
• Since the assesse could not provide any such evidence, this left no option to the AO but to reject the
DCF method and to go by NAV method to determine the FMV of the shares
B. Judgements against the Assessee
Delhi Tribunal
Agro Portfolio Private Ltd
Vs
ITO
The Hon’ble Tribunal held that in case the valuation under DCF is done on the projections provided by
the Management and the valuer (under DCF method) has categorically mentioned in the report as a
disclaimer that the truthfulness, accuracy and completeness of the information and financial data has
been provided by the company and the valuer has relied on the same, the assessing officer can reject
the DCF method and go by NAV method to determine the FMV of the shares.
Can the Tax officer compare revenues/ profits projected under DCF method vis-à-vis
actual revenue/ profit of the company and reject the valuation report?
14. Innoviti Payment
Solutions Pvt Ltd
Vs
ITO
Bangalore Tribunal
• The Hon’ble Tribunal held that the AO can scrutinize the valuation report and if not satisfied with the
explanation of the assessee, he has to record the reasons and basis for not accepting the valuation report
submitted by the assessee and only thereafter, he can go for own valuation or to obtain the fresh valuation
report from an independent valuer and confront the same to the assessee. But the basis has to be DCF
method and he cannot change the method of valuation which has been opted by the assessee
• It also held that it is the primary onus of the assessee to satisfy about the "correctness" of the projections,
discounting factor and terminal value etc with the help of empirical data or industry norm if any and/or
scientific data, scientific method, scientific study and applicable guidelines regarding DCF method of
valuation
A. Judgements favourable to the Assessee
Mumbai Tribunal
DCIT
Vs
Ozoneland Agro Pvt Ltd
It was held that section 56 allows the assessee to adopt one of the methods of their choice. The AO had
held that the assessee should have adopted only one method for determining the value of the shares. It
is beyond the jurisdiction of the AO to insist upon a particular system, especially the Act allows to choose
one of the two methods. Until and unless the legislature amends the provision of the Act and prescribes
only one method for valuation of the shares, the assessee is free to adopt any one of the methods
Does the assessee have an option to adopt either NAV or DCF method for valuation
of shares?
15. Vodafone M-Pesa Ltd
Vs
PCIT
Bombay High Court
• The Hon’ble High Court of Bombay held that the AO is undoubtedly entitled to scrutinize the valuation
report and determine a fresh valuation either by himself or by calling for a final determination from an
independent valuer to confront the assessee. However, the basis has to be the DCF Method and it is
not open to the AO to change the method of valuation which has been opted for by the assessee
• This view also finds support in the rulings of the Jaipur bench of the Tribunal in Rameshwaram Strong
Glass Pvt Ltd vs ITO and ACIT vs Safe Decore Pvt Ltd
A. Judgements favourable to the Assessee (Cont.)
Delhi Tribunal
Cinestaan Entertainment
(P) Ltd
Vs
ITO
• The Hon’ble Tribunal held that if the statute provides that the valuation has to be done as per the
prescribed method and if one of the prescribed methods has been adopted by the assessee, then AO
has to accept the same and in case he is not satisfied, then we do not we find any express provision
under the Act or rules, where AO can adopt his own valuation in DCF method or get it valued by some
different valuer
• In any case, if law provides the assessee to get the valuation done from a prescribed expert as per the
prescribed method, then the same cannot be rejected because neither the AO nor the assessee have
been recognized as expert under the law
India Today Online (P.) Ltd
Vs
PCIT
Delhi Tribunal
Where assessee allotted shares of a company held by it on premium and substantiated valuation of
shares to satisfaction of the AO that same was on basis of valuation report provided by valuer of said
company whose shares were held by it, wherein valuer had applied Direct Cash Flow (DCF) method
and said report was certified by an independent Chartered Accountant and the AO accepted such
valuation, Commissioner (Appeals) was unjustified in rejecting impugned valuation or valuation
method
Does the assessee have an option to adopt either NAV or DCF method for valuation
of shares?
16. B. Judgements against the Assessee
Delhi Tribunal
Agro Portfolio Private Ltd
Vs
ITO
• This precedent has been discussed earlier.
• The Hon’ble Tribunal held that in case the valuation under DCF is done on the projections provided
by the management and the valuer (under DCF method) has categorically mentioned in the report as
a disclaimer that the truthfulness, accuracy and completeness of the information and financial data
has been provided by the company and the valuer has relied on the same, the assessing officer can
reject the DCF method and go by NAV method to determine the FMV of the shares.
TUV Rheinland NIFE
Academy Pvt Ltd
Vs
ITO
Bangalore Tribunal
• This precedent has been discussed earlier.
• The Hon’ble Tribunal considered the AO’s finding that the projections taken in the valuation were a
long way away from the actual figures .
• It held that unless and until the assessee produces the evidences to substantiate the basis of
projections in cash flow and provides reasonable connectivity between those projections in cash flow
with the reality evidences by the material, it is not possible even for the Departmental Valuation
Officer to conduct any exercise of verification of the acceptability of the value determined.
• Since the assesse could not provide any such evidence, this left no option to the AO but to reject the
DCF method and to go by NAV method to determine the FMV of the shares.
Does the assessee have an option to adopt either NAV or DCF method for valuation
of shares?
17. Can the provisions of Section 56(2)(viib) be invoked in spite of the fact that
satisfactory explanation has been provided under Section 68 of IT Act?
Judgement against the Assessee
Sunrise Academy of
Medical Specialties
(India) (P) Ltd
Vs
ITO
Kerala High Court
• The Hon'ble High Court of Kerala has held that any premium received by a Company on sale of shares,
in excess of its face value, if the company is a private company, would be treated as income from other
sources, as seen from Section 56(2)(viib) of the Act, which can be controlled by the provisions of
section 68 of the Act. Section 68 on the other hand, as substituted with the proviso, treats any credit in
the books of accounts, even by way of allotment of shares for which no satisfactory explanation is
offered, to be liable to income tax
• Section 56(2)(viib) is triggered at the stage of computation of income itself when the share application
money received, from a resident, by a private company, is above the face value
• If Section 68 is applicable, and the proviso is not satisfied, then the entire amounts credited to the books
would be treated as income. If satisfactory explanation is offered as to the source, then the premium
paid as revealed from the books will be brought to tax as income from other sources
18. Key aspects for Consideration
Private companies in India may consider the following key aspects of taxation on excess premium received
over FMV on issue of shares from a resident investor
A. Actuals vs Projected
DCF values
B. DCF or NAV method
of valuation
• Valuation of shares using DCF method is based on projections of future events
and cannot be estimated with 100% accuracy. Therefore, a valuation report by a
chartered accountant or a merchant banker cannot be compared with the actual
results at a later point in time
• However, the Management providing information for projections should be able
to substantiate to the tax officer, such information based made available during
valuation process to arrive at the share/ enterprise valuation
• Section 56(2)(viib) read with Rule 11UA prescribes two methods for
determination of FMV of the shares, ie DCF or NAV method, on the date of issue
of shares. It is at the option to choose one of the two options for valuation of its
shares
• The tax officer shall, during scrutiny of the valuation report, either propose
adjustments or obtain fresh valuation of the shares. Nonetheless, the method of
valuation as adopted by the Company should not be changed during the course
of its tax assessment
Valuation of shares to determine FMV
19. Annexure – List of
Start-ups approved by IMB
for income tax benefits