Section 56(2)(viib) Angel Tax Abolition 2024: Retrospective Refund Rights of Startups Assessed Between 2012–2024

The Twelve-Year Burden: What Was Angel Tax?

When Finance Minister Pranab Mukherjee introduced the Finance Act, 2012, he inserted a clause into the Income Tax Act, 1961 that would go on to haunt Indian startups for over a decade. That clause was Section 56(2)(viib), the provision colloquially known as “angel tax.” In plain terms, it treated the share premium received by a closely-held, unlisted company — when shares are issued at a price exceeding their fair market value — as income chargeable under the head “Income from Other Sources.” [1] The excess consideration above the fair market value was taxed at an effective rate of 30.9%, inclusive of applicable cess. The fair market value itself was to be computed by reference to Rule 11UA of the Income Tax Rules, 1962, which provided two methodologies: the Net Asset Value (NAV) method and the Discounted Cash Flow (DCF) method.

The stated purpose behind this insertion was anti-abuse: Parliament was concerned about the entry of unaccounted money into the economy through the mechanism of inflated share premiums in private companies. The Memorandum to the Finance Bill, 2012 placed both Section 68 (relating to unexplained cash credits) and Section 56(2)(viib) under the heading “Measures to Prevent Generation and Circulation of Unaccounted Money.” The legislative intent was therefore narrow and specific — to target shell company transactions masquerading as legitimate equity investments. [2] What Parliament perhaps did not anticipate was the extent to which this provision would sweep up genuine early-stage startup investments within its net.

Regulatory Architecture: How It Was Governed

The mechanics of angel tax were governed at three levels: the primary statute, the rules, and executive notifications from CBDT and DPIIT. Section 56(2)(viib) as originally enacted applied only to consideration received from residents of India. The proviso carved out an exception for consideration received from venture capital companies, venture capital funds, and classes of persons notified by the Central Government — a carve-out that would later be used to extend relief to startups through the notification route. [3]

Rule 11UA of the Income Tax Rules, 1962 was the key operational provision. It specified the formulae for computing the fair market value of unquoted equity shares. The CBDT amended Rule 11UA vide notification dated July 12, 2017, revising the formula for determining fair market value. The rule permitted companies to opt for either the NAV or DCF method, but the choice of methodology became a persistent battleground between startups and Assessing Officers. The AOs routinely rejected the DCF valuations submitted by startups on the ground that projected revenues were speculative, which triggered a wave of litigation across ITAT benches nationwide.

In 2018, the DPIIT stepped in. Vide notification dated April 11, 2018, it exempted private limited companies recognised by it under the Startup India programme from the applicability of Section 56(2)(viib), subject to conditions. Those conditions were subsequently revised by notification dated February 19, 2019, which expanded the turnover threshold from ₹25 crore to ₹100 crore and extended the startup recognition period from seven to ten years from the date of incorporation. [3] CBDT further issued Notification No. 13/2019, laying down the specific conditions for exemption through Form-2 declarations. In May 2023, CBDT issued Gazette Notification S.O. 2274(E), exempting certain foreign entities from 21 specified jurisdictions — including the United States, United Kingdom, Japan, and Australia — from the ambit of the provision, provided they were regulated in their home jurisdiction. [3]

Despite these layered exemptions, the structure remained fragile. Startups that crossed any threshold — paid-up capital exceeding ₹25 crore, or an inadvertent end-use violation — risked retrospective revocation of their exemption. The DPIIT notification expressly provided that if a startup invested in prohibited asset classes within seven years of the share issuance, the exemption under Section 56(2)(viib) would be revoked with retrospective effect.

The Litigation Landscape: Case Law on Section 56(2)(viib)

The twelve years of angel tax’s operation produced a substantial body of judicial and quasi-judicial authority, most of it generated at the level of the Income Tax Appellate Tribunals and, in certain landmark cases, the High Courts.

The Bangalore ITAT, in M/s. Innoviti Payment Solutions Pvt. Ltd. v. ITO [TS-4-ITAT-2019(Bang)], laid down foundational guidelines on the scope of AO scrutiny under Section 56(2)(viib). The Tribunal held that while an AO may scrutinise the valuation report, the AO cannot compel a company to abandon the methodology it has legally elected. If the assessee has opted for the DCF method as permitted under the Rules, the AO’s role is to examine whether the methodology has been applied correctly — not to substitute a different method of the AO’s own preference. [4]

The Jaipur ITAT, in Rameshwaram Strong Glass (P.) Ltd. v. ITO, reinforced this position by holding that DCF projections, being estimates grounded in available material at the time of valuation, cannot be invalidated merely because actuals diverged from projections. The Tribunal observed that even a company yet to commence production or business can legitimately command a share premium, and that the absence of historical revenue is not a ground to reject a DCF-based valuation altogether. [4]

Perhaps the most consequential ruling on the methodology question came from the Delhi High Court in Commissioner of Income Tax v. Cinestaan Entertainment Pvt. Ltd., decided on March 1, 2021. In this case, the tax department had challenged the DCF valuation method adopted by the startup, arguing that projections had not materialised. The division bench of Justice Manmohan and Justice Sanjeev Narula dismissed the department’s appeal and upheld the ITAT order dated May 27, 2019 in favour of Cinestaan. The Court held that both NAV and DCF are “widely accepted methodologies of valuation” and that once a startup has elected the DCF method in compliance with the rules, the Revenue cannot question that election merely because it prefers a different outcome. [5] The Court further observed that investors who have accepted a valuation after independent due diligence cannot be second-guessed by tax officers applying purely retrospective scrutiny.

The Ahmedabad ITAT, in M/s. Ozone India Ltd. (I.T.A. Nos. 2081/Ahd/2018), confronted the application of Section 56(2)(viib) to shares issued in the course of a court-approved amalgamation. The Tribunal held that the legislative purpose of the provision — to deter unaccounted money — simply did not apply to a statutory reorganisation conducted under a scheme sanctioned by the High Court of Gujarat. Deeming provisions must be construed strictly and cannot travel beyond the purpose for which they were enacted. [5]

The Bombay High Court addressed the procedural limits of tax reassessment in the context of SLS Energy Pvt. Ltd. v. ITO [TS-359-HC-2023(BOM)]. The assessee had raised ₹6.8 billion by issuing preference shares during FY 2011-12, before Section 56(2)(viib) came into force in FY 2012-13. The Court quashed the reassessment, holding that the tax authorities lacked “reason to believe” that income had escaped assessment and, critically, that a transaction pre-dating the insertion of the provision could not be taxed under it. The Court relied on its earlier decision in Vodafone India Services P. Ltd. v. Union of India, (2014) 368 ITR 1 (Bom), to reinforce the principle that share application money constitutes a capital receipt that does not ordinarily give rise to income. [6]

The Finance Act, 2024: Abolition of Angel Tax and Its Immediate Scope

On July 23, 2024, Finance Minister Nirmala Sitharaman tabled the Finance Bill, 2024, proposing, through Clause 23, the deletion of Section 56(2)(viib) from the Income Tax Act, 1961. The Finance (No. 2) Act, 2024, as enacted, rendered the provision ineffective from April 1, 2025, meaning it would have no application from Assessment Year 2025-26 (Financial Year 2024-25) onwards. [1] The Bill additionally provided that this amendment would be deemed to have come into force on April 1, 2024. The practical effect of that deemed date is limited but significant in one respect: it means that assessments relatable to FY 2024-25 (AY 2025-26) are not tainted by the provision at all.

Notably, Budget 2024 proposed the complete abolition of the angel tax extension to non-resident investors, reversing the changes introduced by the Finance Act, 2023. This move makes the angel tax exemption total and unconditional for all investors, both resident and non-resident. However, no corresponding amendment was made to the definition of “income” under Section 2(24)(xvi) of the Income Tax Act, which still references income under Section 56(2)(viib). According to KPMG India, this legislative gap may create interpretive ambiguity for pending assessments, highlighting the need for a CBDT clarificatory circular to ensure smooth implementation of the angel tax abolition. [7]

The Retrospective Refund Question: What Happens to Startups Assessed Between 2012 and 2024?

This is the sharpest and most practically consequential dimension of the angel tax abolition, and it is the one on which the statute is conspicuously silent. Clause 23 of the Finance Bill, 2024 operates prospectively: it removes the provision for Assessment Year 2025-26 onwards. It does not, on its face, annul or reverse assessments that were completed, demands that were raised, or taxes that were paid under Section 56(2)(viib) during the period from FY 2012-13 to FY 2023-24. [8]

The Singhania & Co. analysis of the abolition noted this expressly: pending cases and investigations relating to angel tax violations initiated before April 1, 2024 remain unaffected and proceedings will continue. [8] This creates an acute asymmetry — a startup that was assessed and paid tax on a share premium received in, say, FY 2018-19, obtains no automatic relief from the Finance Act, 2024. Its demand and tax payment, if crystallised through a completed assessment order, remains valid in law.

Startups seeking refunds of angel tax paid on past assessments must therefore navigate existing statutory remedies. Where an assessment is still pending before the Commissioner of Income Tax (Appeals) or the ITAT, the fact of abolition is a strong persuasive argument — courts interpreting taxing statutes generally give effect to the legislative policy reflected in subsequent amendments, particularly where those amendments reflect a settled intention to treat the underlying transaction as non-taxable. The ITAT’s existing body of case law, including Cinestaan and Rameshwaram Strong Glass, supports deletion or reduction of additions made on valuation disputes. [5]

Where an assessment has been finally concluded — meaning the order has attained finality after exhaustion of appeals, or the limitation period for appeal has passed — there is no automatic refund. The taxpayer would need to explore the rectification route under Section 154 of the Income Tax Act for patent errors, or, in appropriate cases, invoke the revisionary jurisdiction of the Commissioner under Section 264. In cases where the tax department has adjusted refunds arising from other years against outstanding angel tax demands, startups can apply for reversal of such adjustments if the underlying demand is vacated on appeal. The Mysore-based startup VigyanLabs, which reported that its IT refunds from FY 2016-2018 were adjusted against angel tax demands, represents precisely this category of hardship that pending litigation could potentially address. [5]

The absence of a specific CBDT circular or amnesty scheme for completed assessments remains the most significant gap in the post-abolition framework. KPMG and Lexology analyses both flagged that the government needs to issue clarificatory guidance on transitional treatment of pending assessments. [7][8] Without such guidance, startups continue to carry the procedural burden of appeals and rectification applications to recover taxes paid on what Parliament has now implicitly acknowledged was a provision that caused collateral damage to legitimate businesses.

What the Abolition of Angel Tax Does Not Fix: Section 68 and the Residual Burden

Even with Section 56(2)(viib) gone, startups that raised funds from angel investors face a parallel scrutiny risk under Section 68 of the Income Tax Act, 1961. Section 68 permits the tax officer to treat unexplained cash credits as income of the year in which they are credited, if the assessee fails to satisfactorily explain the nature and source of the credit. The KPMG analysis specifically identified Section 68 as a residual concern — the investor’s source of funds and the genuineness of the investment can still be questioned under Section 68 even though the valuation-based addition under Section 56(2)(viib) is no longer available. [7] This is a distinct and potentially more invasive scrutiny because it targets the identity and creditworthiness of the investor, not merely the share price.

The Broader Policy Context and What Comes Next

India has, as of June 2024, recognised over 140,803 startups through DPIIT, which together have generated over 1.553 million direct jobs. [3] The abolition of angel tax is consistent with the broader Startup India policy framework and with India’s competitive positioning against jurisdictions like Singapore, Delaware, and the United Kingdom as preferred domiciles for early-stage companies. The Finance (No. 2) Act, 2024 removes a provision that had, in the estimation of most practitioners and policymakers, outlived its utility — it deterred legitimate investment while sophisticated money-laundering actors found other mechanisms.

The outstanding need, which multiple commentators have raised, is for a structured resolution framework for the 2012-2024 assessment cohort. That framework should ideally include an administrative circular from CBDT directing AOs not to pursue further recovery under completed angel tax assessments, a fast-track appellate disposal mechanism for pending cases, and clarity on whether adjustments of refunds against angel tax demands will be reversed where the demand is subsequently set aside. Until that guidance arrives, the abolition is symbolically important but practically incomplete for the many startups that are still waiting to get their money back.

References

[1] Legal500, Abolition of Angel Tax in India: A Boost for the Startup Ecosystem (November 2024) — https://www.legal500.com/developments/thought-leadership/abolition-of-angel-tax-in-india-a-boost-for-the-startup-ecosystem/

[2] Vinod Kothari Consultants, Finance Bill 2023 Amends Section 56(2)(viib): How Will It Impact the Startups? — https://vinodkothari.com/2023/02/finance-bill-2023-amends-section-562viib-how-will-it-impact-the-startups/

[3] India Briefing, Abolishing the Angel Tax in India: Applicable for FY 2025-26 (December 2024) — https://www.india-briefing.com/news/abolishing-the-angel-tax-in-india-applicable-for-fy-2025-26-35289.html/

[4] Taxguru, Exemption to Start Ups from Provisions of Section 56(2)(viib) — https://taxguru.in/income-tax/exemption-start-ups-provisions-section-562viib.html

[5] Inc42, Will Delhi HC Ruling Be the Saviour for Indian Startups Held Back by Angel Tax? (March 2021) — https://inc42.com/buzz/will-delhi-hc-ruling-rescue-indian-startups-hit-by-angel-tax-issues/

[6] Cyril Amarchand Blogs, Share Subscription Above Fair Market Value Would Be Subject to Angel Tax (July 2023) — https://tax.cyrilamarchandblogs.com/2023/07/share-subscription-above-fair-market-value-would-be-subject-to-angel-tax/

[7] KPMG India, Abolishment of Angel Tax – A Welcome Move (August 2024) — https://kpmg.com/in/en/blogs/2024/08/abolishment-of-angel-tax-a-welcome-move.html

[8] Singhania & Co., Angel Tax Abolished: A Relief for Indian Startups — https://singhania.in/blog/the-end-of-angel-tax-and-its-implications

[9] EY India, How Amendments in Angel Tax Will Impact Companies — https://www.ey.com/en_in/insights/tax/how-amendments-in-angel-tax-will-impact-companies