Startups with sales of up to Rs. 100 crore—earlier, the exemption limit was Rs. 25 crore—would be eligible for angel tax relief. An entity will be considered a startup for up to 10 years from the date of incorporation, up from the earlier seven years

The government on Tuesday eased norms for startups facing tax demands for selling shares at a premium to their fair market value and also expanded eligibility of companies that could benefit from the move, in a relief to new businesses and their investors. The relief from the so-called angel tax will be available to all eligible startups retrospectively, with the government deciding not to pursue such cases until their appeals are disposed of. The changes are expected to encourage wealthy individuals to invest in startups that receive capital at a premium on account of their innovative business model although the valuation is not justified by the physical assets they hold.

“The blanket exemption from angel tax for startups is a welcome change for the industry as it would make it easier for indigenous innovation to thrive in our country,” said AnkitMehrotra, co-founder and chief executive of Dineout. The government’s move follows protests by startups and angel investors about what they termed as unjustified tax demands. The industry ministry’s notification addresses some of their core demands.

Under the new rules, startups will be kept out of the purview of an anti-tax evasion provision in the Income Tax Act, 1961, under which share premium received beyond the fair value is taxed at 30%. Section 56 (2) (viib) of the Act has come to be known as angel tax as wealthy individuals or angel investors putting their capital in startups faced scrutiny. About 100 startups have been issued tax demand notices under the section.

This clarification would allow startups to focus on their core activities, said Bhavin Shah, financial services tax leader at PwC India.

According to the government’s decision, investments up to Rs. 25 crore will be exempted from section 56 (2) (viib) of the Income Tax Act, up from Rs. 10 crore before. Also, startups with sales of up to Rs. 100 crore—earlier, the exemption limit was Rs. 25 crore—would be eligible for the tax relief, said a commerce ministry statement. According to the government’s decision, an entity will be considered a startup eligible for relief for up to 10 years from the date of incorporation, up from the earlier seven years.

“The turnover exemption will provide relief to a significant proportion of the smaller startups that were being targeted previously by the (tax) notices issued,” said RohintonSidhwa, partner at Deloitte India. Such entities would not be questioned about the share premium they receive if they are registered with the department for promotion of industry and internal trade (DPIIT), the statement said. The share premium received should not be invested in land, residential building other than those held as stock in trade or occupied, rented or used by the business. The entity should also not invest the premium into shares and securities, jewellery or in vehicles priced above Rs. 10 lakh other than those used by the entity in the ordinary course of business.

The government has decided to exempt from angel tax the receipts of startups from share sales to listed firms with net worth of Rs. 100 crore or annual sales of Rs. 250 crore. Premium received from non-residents and alternative investment funds-category 1 registered with the Securities and Exchange Board of India (Sebi) will also be eligible for the exemption. Startups have to file a declaration with DPIIT seeking relief, which it would share with the tax department, said the statement. Taxation of share premium received by startups has been a headache for new-age businesses at a time the government has been promoting innovation and entrepreneurship.