Angel Tax In India: All You Need To Know

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  • 24 Feb 2023

_Italic_Startups are one of the biggest businesses in today’s era. They are a major source of employment and revenue. Famous startups from across the world include Alibaba, Uber, Airbnb and Xiaomi; they are considered to be among the unicorn startups across the world. The plethora of schemes such as ‘Startup India’, launched by the Indian Government support the dreams of entrepreneurs who wish to launch a startup. Angel tax is a potential concern among entrepreneurs launching startups and angel investors. So, let’s understand what is angel tax.

Angel tax was introduced in the Union Budget 2012 by then Finance Minister Pranab Mukherjee with the purpose of keeping money laundering in check. Angel tax is a tax levied at 30.9% on the funding received by startups from an external investor. This tax is levied only when startups receive angel funding at a valuation higher than its ‘fair value’. The funding received is counted as income to the company and is taxed.

The term is called angel tax as it largely impacts angel investments in startups.

Since startups have only a few sources of mainstream funding, investors and startups urged for the tax to be removed.

The funds sourced from non-residents and venture capital funds were already exempt from this tax. Now, the Centre has moved to exempt investments made in companies certified as ‘innovative’ startups by Indian residents, from angel tax.

To qualify for exemption, the venture must fulfill the criteria mentioned below

  • Age- The startup should not be more than five years old
  • Turnover- Should not exceed Rs 25 crore
  • Purpose- It should be focused on building new product or services
  • Method- Technology or intellectual property.

Also, it must be officially recognised as an ‘innovative’ startup by the Inter-ministerial Board of Certification.

When it comes to ‘fair value’, there is no definitive or objective way of measuring the fair value of a startup. At the angel funding stage, investors invest by looking at the business potential and the idea of the business. But, tax officials assess the value of the startups based on their Net Asset Value (NAV) at one point.

Also, taxing this investment drives away angel investors. It limits investors from investing money and trusting early-stage startups. This concern has been raised by multiple entities, right from entrepreneurs to angel investors.

Many early-stage and unlisted startups depend heavily on funding from angel investors to build the basics of the company so that they can further get their funding from VC groups

In contrast to the idea of taxing angel investors, investors in countries like the US are actually offered tax benefits when they fund small firms. Also, there are ways for angel investors to save tax by re-investing gains from one small business into another venture.

Australia’s tax incentives for investment in innovative startups have been called ‘arguably the most generous in the world’. Singapore also offers tax incentives to investors and startups, even offering qualifying startups up a tax exemption up to $200,000 Singapore dollars on their first three consecutive years of assessment (YAs).

European countries like the UK and Germany have passed laws and implemented policies to offer generous tax incentives to angel investors and startups.

However, here in India, there was an element of suspicion over startup investments. Several startups complained saying that they find it difficult to justify the higher valuation to tax officials.

Notification From The Central Board Of Direct Taxes

In a notification by the Central Board of Direct Taxes (CBDT) dated 24 May 2018, angel investors were exempted from angel tax subject to fulfillment of certain terms and conditions specified by the Department of Industrial Policy and Promotion (DIPP).

This relief is limited to small start-ups with paid-up capital and share premium up to Rs. 10 crore after the share issue. The angel investor should have had Rs. 2 crore net worth at the end of the previous fiscal or Rs. 25 lakh average income in the preceding 3 years. Thus, this exemption is available only to a few number of startups.

In a recent notification by the CBDT dated 19 Feb 2019, the government took a step to relax angel tax norms for startups. The government has stated that as per the new notification, an entity that has been in operation for 10 years, instead of 7 years as per the current rule, from its date of incorporation or registration shall be considered as a start-up.

Coming to the tax exemptions, the government notified that the consideration for the share sale, including premium up to Rs. 25 crore, will be exempted from the provisions of Section 56 (2) (viib) of the Income Tax Act, 1961

As per the notification, for a start-up to become eligible for exemption under Section 56(2)(viib), it should not be investing in immovable property, transport vehicles above Rs. 10 lakh, including loans & advances, capital contribution to other companies. Moreover, the start-up should be a private limited company that is recognised by the Department for Promotion of Industry and Internal Trade (DPIIT). Also, the start-up should not invest in asset classes specified by the government.

As opposed to the earlier sales threshold of Rs. 25 crores, sales thresholds up to Rs. 100 crores will be considered eligible for the tax relief. The government has exempt the receipts of startups from share sales to listed companies with a net worth of Rs. 100 crore or sales of Rs. 250 crore.

The government also notified that investment in recognized start-ups by non-residents, alternative investment funds- Category I registered with SEBI will also be eligible for the exemption beyond the limit of Rs. 25 crore.

To exempt from the angel tax, the notified startups are required to submit a self-certified declaration along with income tax returns and audited financials with the DPIIT. Then, the DPIIT will share these with the CBDT.

In conclusion, the government of India has taken some steps to ease the worries of Indian startups about angel tax. But, will these revisions to angel tax satisfy the start-ups-- only time will tell!

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