Government recently proposed in tax rules for investments made by Indian residents in startups, also known as Angel Tax.
Department for Promotion of Industry and Internal Trade (DPIIT) issued notification in April 2018 for easing the norms for providing tax exemption to the Startup companies and further amended the notification recently.
Angel Tax is a 30% tax that is levied on the funding received by startups from an external investor. However, this 30% tax is levied when startups receive angel funding at a valuation higher than its ‘fair market value’.
It is counted as income to the company and is taxed. It was introduced by in 2012 to fight money laundering. The stated rationale was that bribes and commissions could be disguised as angel investments to escape taxes.
But given the possibility of this section being used to harass genuine startups, it was rarely invoked.
In a notification dated May 24, 2018, the Central Board of Direct Taxes (CBDT) had exempted angel investors from the Angel Tax clause subject to fulfillment of certain terms & conditions, as specified by Department of Industrial Policy & Promotion (DIPP).
DEFINITION OF A START UP
- Upto a period of seven years from the date of incorporation/registration, if it is incorporated as a Private limited company (as defined in the Companies Act, 2013) or
- Registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or
- A limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
- In the case of Startups in the biotechnology sector, the period shall be upto ten years from the date of its incorporation and registration.
- Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded Rs. 25 crore
- Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
Impact of Angel Tax
This tax usually impacts startups and the angel investments they attract. Angel tax has also resulted in large number of genuine startups receiving tax notices. Start-up owners have complained that income tax officials have asked many start-ups to cough up money when they try to attract capital into their entities by issuing new shares.
In trying to curb money-laundering, Section 56(2)(viib) of the Indian Income Tax Act, 1961 gives income tax officials a free hand to harass even genuine start-ups looking to raise investments for their growth.
Investors, foreign or domestic, may become wary of investing in new ideas when they are taxed while risking money on untested ventures.
Why is Angel tax problematic?
- There is no definitive or objective way to measure the ‘fair market value’ of a startup, but tax officials seem to be assessing the value of the startups based on their net asset value at one point.
- Start-up owners have complained that income tax officials have asked many startups to pay up the money when they try to attract capital into their entities by issuing new shares because the IT department fears that start-ups may be used as convenient tools to launder illegally acquired money.
Issues with Income Tax Notices
In 2018, the Central Board of Direct Taxes (CBDT) had exempted angel investors from
the Angel Tax clause subject to fulfillment of certain terms and conditions, as specified
by the Department of Industrial Policy and Promotion (DIPP) and the reasons put
forward by the Income Tax Department to send such notices is to get information for
distinguishing the genuine startups from the bogus ones. However, despite the
exemption notification, there are issues are yet to be resolved.
Improvements by Govt
- Registered start-ups are exempted from giving Angel Tax.
- If Angel investment is upto 25 Crore Rupees then, Angel tax is exempted.
- A listed company with net worth of at least 100 crore or turnover Rs 250 Crore will also not be taxed if they make investment in a start up
- Investments by NRI into Start-ups will also not attract any Angel Tax.
Earlier they were taxed as Other Properties of The Investor. This is done to provide a safeguard to the investors in StartUps which indeed a very risky as well as credit starved sections of business.
Recently, the Centre set up a five-member working committee to look into revising the
norms of the angel tax imposed on startups.
Global Scenario-Need to learn
More and more governments are recognizing the usefulness of encouraging and inviting angel investors to boost their startup economies. Many global startup hubs in fact offer amazing tax cuts and incentives to attract investors.
- China allows 70% of total investment to be deducted from taxation two years after investment in high-tech startups.
- In Europe, countries like Germany and UK have passed laws and implemented policies to offer generous tax incentives to startups and angel investors.
- Across the world, Australia’s tax incentives for investment in innovative startups
have been called “arguably the most generous in the world”.
According to experts, govt should raise threshold beyond which new investments into start-ups will be taxed. It is expected that start-ups with aggregate paid-up share capital and share premium of less than Rs. 25 crore, against the previous threshold of only Rs.10 crore, will not be taxed while attracting new investment.
In long term, government should withdraw angel tax and instead build capability to better identify and rein in illegal wealth. Otherwise it will kill the start-up ecosystem in the country.
Government should look to withdraw the angel tax and focus instead on building the capability to better identify and rein in illegal wealth.
Though Government recently made the exemption process less bureaucratic.
Instead of an inter-ministerial group, applications will now go to the department
for the promotion of industry and internal trade (DIPP), which will forward them to the central board of direct taxes (CBDT) for approval. But lot to be done in order to make a better environment for startups.
Q] What do you understand by Angel Tax? What is the need for this new tax? How can it affect startups in India? What should be done for safeguarding the interests of genuine startups in India?