Issuing Shares at a Premium? Here’s When the Excess Becomes Taxable

Introduction

Issuance of shares at a premium is often seen as a positive sign for companies raising funds. But what happens when the consideration received by a company for issued shares exceeds both the face value and the fair market value (FMV) of those shares? Under the Indian tax regime, such excess consideration for shares issued at premium may trigger liability under Section 56(2)(viib) of the Income‑tax Act, 1961 — commonly referred to as “angel tax”. This article explains the taxability of such excess premium in simple terms, the key facts, the valuation rules, exemptions for start-ups and venture capital, and the practical take-aways for companies, investors and tax professionals.
(Keywords: share premium taxability, excess consideration for shares, Section 56(2)(viib), fair market value shares, angel tax India.)

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Facts of the Case

• The provision applies when a closely held company (i.e., a company “not being a company in which the public are substantially interested”) issues shares (equity or preference) and receives from any person (resident or non-resident) a consideration for the issue of the shares that exceeds the face value of the shares and exceeds the fair market value (FMV) of the shares on the date of issue. TaxGuru+2TaxGuru+2
• When those conditions are satisfied, the aggregate amount of consideration received for such shares in excess of the FMV is taxable in the hands of the issuing company under the head “Income from Other Sources”. TaxGuru+2TaxGuru+2
• The FMV is determined by the higher of:
  1. Value as per methods prescribed under Rule 11UA of the Income‑tax Rules, 1962 (i.e., book value or discounted cash flow) or
  2. Value substantiated by the company to the satisfaction of the Assessing Officer (AO) on the date of issue, based on tangible and intangible assets (goodwill, patents, trademarks etc). TaxGuru+1
• Exemptions: The clause does not apply when the consideration is received by a venture capital undertaking from a venture capital company/fund or by a start-up fulfilling prescribed conditions. TaxGuru+1
• Recent change: The government has proposed winding down this clause for issues made on or after 1 April 2025 (Assessment Year 2025-26 onwards) as part of ease-of-doing-business reforms. TaxGuru

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Discussion

Why the provision was introduced

The tax on excess premium was introduced to prevent misuse of share premium route by closely held companies to hide unaccounted money or inflate capital without proportionate disclosures. TaxGuru+1
When a company issues shares at a huge premium above FMV, it may be viewed as a disguised way of bringing in undeclared funds — hence the policy rationale.

Key triggers and applicability

• Closely held company status at the time of receipt of consideration is crucial. If the company is not closely held, this clause won’t apply. TaxGuru+1
• The amount received must exceed both the face value and the FMV of shares. If only face value is exceeded but price ≤ FMV, the tax may not apply.
• The person from whom consideration is received doesn’t need to be a non-resident; residents also trigger the clause. TaxGuru
• Valuation of FMV under Rule 11UA: The company may choose either the NAV book value method or the DCF method; whichever is higher must be used. The AO has the powers to scrutinise the assumptions used in DCF. TaxGuru+1

Exemptions & start-up angle

• Start-ups recognised by Department for Promotion of Industry and Internal Trade (DPIIT) can claim exemption if after issue the aggregate paid-up share capital + share premium ≤ ₹ 25 crore and other conditions are satisfied (e.g., not investing in certain specified assets for 7 years). TaxGuru
• Similarly, if the consideration is received by a venture capital undertaking from a VC company/fund, the clause does not apply. TaxGuru

Recent amendment and sunset

• As part of the Finance Bill 2024 reforms, it is proposed that clause (viib) of Section 56 will not apply for issues made on or after 1 April 2025 — meaning companies issuing shares at premium post that date will not face this tax. TaxGuru
• This shift signals Government’s intent to ease the regulatory burden for fund-raising and boost start-up investments.

Practical implications and compliance for companies

1. Before issuing shares at a premium, closely held companies must ensure that issue price ≤ FMV (or they are comfortable with tax on excess).
2. Prepare a robust valuation report, especially if using DCF. Ensure assumptions are reasonable since AO might challenge them.
3. If claiming start-up exemption, maintain compliance with DPIIT conditions (capital threshold, investment restrictions, filing Form 2 etc).
4. Account for tax on excess premium as income from other sources in the relevant previous year, and be aware of possible penalty under Section 270A for under-reporting if conditions violated. TaxGuru
5. Post 1 April 2025 issue date: Monitor amendments closely and ensure correct date of share issue to ascertain whether clause applies.

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Conclusion

The tax on excess consideration for shares issued at premium under Section 56(2)(viib) has been a significant risk area for closely held companies issuing shares above fair market value. The provision ensures that premium over FMV is not used as a disguised conduit for undeclared funds. With the valuations moving into technical territory (NAV vs DCF), companies must tread carefully. At the same time, the proposed sunset of the clause from AY 2025-26 onwards opens up new flexibility for equity funding and start-up growth. For now, the key take-aways are: validate issue price against FMV, maintain documentation, monitor exemptions if you are a start-up, and stay alert to the regulatory changes ahead.