§ 01 — What The Section Does
Premium above fair market value becomes income
Section 56(2)(viib) of the Income Tax Act applies when a closely held company issues shares at a price above their fair market value. The mechanics are blunt: the excess of the issue price over FMV is treated as income of the issuing company — "income from other sources" — and taxed accordingly. Not the investor's problem, in other words. Yours.
The provision was introduced to counter money-laundering through inflated share premiums, but its reach is much wider than the abuse it targets. Any genuine fundraise at a negotiated premium is potentially within scope, which is why it acquired the nickname "angel tax" — early-stage rounds, priced on potential rather than trailing profits, sit naturally above any formula-driven number.
§ 02 — Where FMV Comes From
Rule 11UA and the prescribed valuer
Fair market value for this purpose is not whatever the term sheet says. Rule 11UA of the Income Tax Rules prescribes how FMV may be determined — historically a choice between a net-asset-value formula and a discounted cash flow supported by a report from a prescribed valuer, with the DCF route requiring a merchant banker's report. The menu of permitted methods and who may sign the report has been amended more than once, so the current text of the rule should be checked before any issue — but the structure has stayed constant: the company must be able to point to a recognised method, applied by a person the rule recognises, as at a date the rule recognises.
That last clause matters more than most founders realise. The valuation is meant to support the price before the shares are issued. A report that carries a date after the allotment is answering a question nobody asked.
§ 03 — Failure Modes
Where reports fall down in assessment
When 56(2)(viib) additions are made, the trigger is rarely an exotic legal argument. It is usually one of three ordinary failures:
- The report post-dates the issue. A valuation commissioned after the allotment — often when the notice arrives — reads as justification, not basis. Officers and tribunals notice the dates.
- Projections nobody can substantiate. A DCF is only as strong as its assumptions. If the projections show revenue quintupling and, three years later, actuals are nowhere close and there is no record of why the projections were reasonable at the time, the report becomes the prosecution's exhibit. Hindsight variance alone should not condemn a projection — but a projection with no documented reasoning has nothing to stand on when it does.
- The narrative doesn't match the pitch. If the pitch deck told investors one growth story and the valuation model quietly assumed another, the inconsistency will surface. Investor materials, board minutes and the valuation report get read side by side in scrutiny.
§ 04 — Scrutiny In Practice
What the conversation actually looks like
Assessment proceedings on share premium tend to follow a pattern: a questionnaire asking for the valuation report, the basis of projections, the identity and creditworthiness of investors, and the correspondence around the round. The officer is testing whether the premium was a considered commercial price or a number reverse-engineered for the money that arrived.
A contemporaneous, well-documented report changes the tenor of that conversation. When the report pre-dates the issue, states its method within the rule, records where each assumption came from, and matches what the company told its investors, the discussion becomes about valuation judgment — where reasonable positions are defensible — rather than about credibility, where they are not. Most matters that go badly go badly on credibility.
§ 05 — A Moving Target
Applicability has shifted — check the current year
The scope of 56(2)(viib) has not stood still. Exemptions for DPIIT-recognised startups were introduced subject to conditions; the provision's application to non-resident investors was extended and then substantially rolled back; permitted valuation methods under Rule 11UA were expanded. Some of these changes arrived mid-year with their own effective dates. This article deliberately describes mechanics rather than current thresholds: before relying on any exemption or method, confirm the position for the year of issue with your tax advisor against the law as it stands then.
§ 06 — Before You Issue
What to have ready before shares go out at a premium
- A valuation report dated before the allotment, from a valuer the current rule recognises, using a method the current rule permits.
- A projections file — the model plus a note recording the basis for each material assumption: pipeline, contracts, market data, hiring plan. Written now, not reconstructed later.
- Consistency across documents — pitch deck, board resolution, valuation report and shareholders' agreement telling the same story about the same business.
- Investor documentation — KYC and source-of-funds basics, since the enquiry often pairs 56(2)(viib) with questions under Section 68.
- A valuer who will still be there — someone who stands behind the report and responds when the questionnaire arrives, not a signature purchased off a template.
None of this is onerous if it is done before the round. All of it is painful to assemble two years later under a deadline. The cheapest insurance against a share-premium addition is a valuation done properly, at the right time, by someone prepared to defend it.
CA Devansh Shah · Member, ICAI · IBBI Registered Valuer (Securities or Financial Assets) · June 2026