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Finance Bill 2023 amends section 56(2)(viib): How will it impact the startups?

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– Abhirup Ghosh, Partner | finserv@vinodkothari.com

Background

The Finance Bill 2023 has proposed amendments to section 56(2)(viib) of the Income Tax Act, which deals with tax on closely held companies for issuance of shares to residents at a premium where the shares are issued at a value higher than the fair market value. The objective of the change is to expand the scope of the section and bring shares issued to non-residents into the reach of the section. This proposal will particularly hit start-ups, which mostly issue equity shares and compulsorily convertible preference shares (CCPS) to their investors, and in most of the start-ups, at valuations which are far higher than the fair values at the time of issuance. 

Before we discuss the impact of the section, let us first understand the scope of the section at length.

Also, it is important to note that the focus of this article is to examine the potential impact of the amendment on startups, since, the majority of the foreign investments into closely held companies flow into the startups, therefore, this section will mostly affect the startup segment.

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AIF Second Amendment Regulations, 2021 – Regulated Steps towards Liberalised Investment

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-Megha Mittal  (mittal@vinodkothari.com)

Amidst the various concerns addressed in the Board Meeting dated 25th March, 2021,[1] the Securities and Exchange of Board of India (‘SEBI’) extensively dealt with several issues identified with respect to Alternative Investment Funds (‘AIFs’), inter-alia a green signal to AIFs for investing in units of other AIFs; ambiguity regarding the scope of the term ‘start-up’; and the need for a code of conduct laying down guiding principles on accountability of AIFs, their managers and personnel, towards the various stakeholders including investors, investee companies and regulators.

Thus, with a view to target the issues in consideration, the Board proposed that the following amendments be introduced in the SEBI (Alternative Investment Funds) Regulation, 2012 (‘AIF Regulations’/ ‘Principal Regulations’)[2] –

  • provide a framework for Alternative Investment Funds (AIFs) to invest simultaneously in units of other AIFs and directly in securities of investee companies;
  • provide a definition of ‘start-up’ as provided by Government of India and to clarify the criteria for investment by Angel Funds in start-ups
  • prescribe a Code of Conduct for AIFs, key management personnel of AIFs, trustee, trustee company, directors of the trustee company, designated partners or directors of AIFs, as the case may be, Managers of AIFs and their key management personnel and members of Investment Committees and bring clarity in the responsibilities cast on members of Investment Committees; and
  • remove the negative list from the definition of venture capital undertaking.

 The aforesaid proposals, put to the fore in view of the suggestions and requests received from several stakeholder groups like the domestic AIFs, global investors, and the regulatory bodies, have now been notified vide notification dated 5th May, 2021, via the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021[3] (‘Amendment Regulations’). A key takeaway from the Amendment Regulations is the flexibility granted w.r.t. indirect investments by AIFs for investment in units of another AIF, however with some riders and possible gaps, as discussed below.

Below we summarise and discuss the amendments introduced vide the Amendment Regulations, and analyse its impact

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