In a judgement dated March 1, the Delhi High Court ruled in favour of Cinestaan Entertainment, a media and entertainment company, in a move that provides startups relief from Section 56 (2) (viib), or what is popularly known as Angel Tax.
The court said that the valuation of a company through prescribed methodology and based on projected revenues cannot be challenged at a later date on the basis of actual revenues.
“Since the performance did not match the projections, revenue sought to challenge the valuation, on that footing. This approach lacks ITA 1007/2019 material foundation and is irrational since the valuation is intrinsically based on projections which can be affected by various factors,” said the court in its judgement.
It added, “In view of the foregoing, we find that the question of law urged by the Appellant-Revenue is purely based on facts and does not call for our consideration as a question of law.”
Incorporated in 2013, Cinestaan had raised Rs 90.95 crore from angel investors Anand Mahindra, Rakesh Jhunjhunwala and Radhakishan Damani, at a share premium of 1:1949 in Mahindra’s case and 1:2602 in the case of other investors, based on a valuation report as on December 2014 using DCF Method.
The income tax assessment officer (AO) issued a notice to the company in 2016, followed by detailed order in 2017, stating that no effort was made by Cinestaan to achieve the projections made in the valuation report, and was contrary to the provisions of section 56(2) (viib).
“This ruling reiterates the same principle that share valuations cannot be disputed merely because subsequent performance did not match the projections. The court has acknowledged the fact that valuation is intrinsically based on projections which can be affected by various factors,” Ritu Shaktawat, partner at law firm Khaitan & Co, told TechCircle. She added, “This ruling will certainly help in defending angel tax related disputes of similar angel investor backed companies.”
Norms around Angel Tax were clarified in 2019 by the Ministry of Finance, exempting startups registered with the Department for Industry and Internal Trade (DPIIT) from provisions of Angel Tax. Multiple startups were served notices under Angel Tax clause in December 2018 and early 2019, taxing early stage investments in the companies at the rate of 30%, treating them as "income from other sources”. This led the government to come up with specific norms of exemption for the startups from Angel Tax in February 2019.