Direct Tax Alert - CBDT provides clarification on assessment proceedings against DPIIT recognised Startups

Background

Section 56(2)(viib) of the Income-tax Act, 1961 (IT Act) before Finance Act 2023 provided that if a closely held company receives any consideration, in excess of face value, for the issue of shares (equity or preference) from any resident investors exceeding the “fair market value” (FMV) of such shares, then such excess amount shall be taxed as Income from Other Sources in the hands of such company. There are certain exemptions on the applicability of the provision viz., investment by notified class of persons etc.

The Finance Act 2023 amended section 56(2)(viib) of the IT Act to make it applicable even in cases where shares are issued to a non-resident with effect from 1 April 2023. Therefore, from 1 April 2023, provisions of section 56(2)(viib) of the IT Act are applicable to an investment made by a resident/ non-resident in a closely held company.

It is pertinent to note that Central Board of Direct Taxes (CBDT) had notified on 5 March 2019 that the provisions of Section 56(2)(viib) of the IT Act shall not apply to the consideration received by a company for issue of shares that exceeds the face value of such shares, if the said consideration has been received from a person, being a resident, by a company which have been notified by the Department for Promotion of Industry and Internal Trade (DPIIT) and fulfils the conditions specified in DPIIT notification¹ dated 19 February 2019.

Since the Finance Act 2023 has amended Section 56(2)(viib) of the IT Act and omitted the words “being a resident”, instances were reported of Startups having been picked up for assessments. In this regard, recently the CBDT has issued a direction² to all Principal Chief Commissioner/Chief Commissioner of Income Tax to re-iterate and clarify the approach with regard to the procedure laid down for assessment of such Startup companies. We, at BDO in India, have hereunder analysed and summarised key provisions of the said direction:

• The case is selected for assessment with the single issue of section 56(2)(viib) of the IT Act

No verification on such issue shall be done by the tax officers during the proceedings under section 143(2) or 147/143(2) of the IT Act and contention of such Startup companies on the issue will be summarily accepted.

• The case is selected for assessment with multiple issues including the issue under section 56(2)(viib) of the IT Act

The issue of applicability of section 56(2)(viib) of the IT Act shall not be pursued during the assessment proceedings of such a startup company. In case of other issues for which the case is selected, due procedures shall be followed.

BDO in India Comments

This a welcome move by CBDT since it provides much-needed clarity with respect to the applicability of angel tax on DPIIT registered startups in case of consideration received from non-residents as well. The direction is expected to provide relief to DPIIT-registered startups who have received assessment notices pertaining to angel tax issues since in such cases tax authorities shall be duty-bound to drop angel tax issues.