The Indian government introduced angel tax in 2012 to snuff out any chance of money laundering through start-ups. New entrepreneurs, however, have been vocal in opposing the implementation of angel tax. This has prompted the government to form a panel to resolve this issue.
Unlisted start-ups can raise money from resident investors by selling their closed shares. Angel tax is levied on start-ups when they receive investments in excess of their ‘fair market value’. The perceived profit is considered as income from other sources—it’s taxed at 30% and termed as angel tax. Note that angel tax isn’t applicable in case of investments made by venture capital firms or foreign investors. It’s limited to investments made only by Indian investors.
It’s difficult to determine the fair market value of a start-up. Section 56 of the Income Tax Act 1961 explains how to calculate this value. It may be determined by considering intangible assets like good will, know-how, patents, licences, copyrights, and movable assets.
However, this definition brews the discontent among start-ups and the income tax department. Income tax is strictly run by the rule book in India. So, it’s not possible to correctly estimate the projected growth of start-ups while calculating the fair value.
Angel investors are wealthy individuals who can supply their own money for a start-up in return for ownership equity. Unlike investment firms, which invest other people’s money in start-ups, angel investors use their own money. These investors are often impressed by the offerings from start-ups and do not look for a profit margin. They might just invest out of goodwill as well.
Other terms used for angel investors are informal investors, angel funders, private investors, seed investors, or business angels. Very few wealthy Indians actually take up this role due to complex taxation policies. A more open system will see more Indians investing in start-up ventures in India.
Related: Tips for Start-up Taxation
In India, unlike in the US, the angel investor does not get any tax rebate for the investment to small businesses. So, people can invest their black money in start-ups and make it legal. Angel tax was introduced to prevent money laundering that might happen in the name of investment.
However, computing the fair market value for a start-up has remained a point of disagreement. Measuring intangible assets is difficult and hence one could get only a subjective rating. But this rating could be considered differently by different people. If the value is placed high, it’ll benefit start-ups as they would have to give up less equity.
Suppose a closely held company issues equity shares and an investor buys those at a price above their fair value. The excess amount received by the company will be treated as income from other sources. The company should pay 30% of the excess amount plus the applicable cess value as tax.
If that closely held company is a start-up, the tax paid on such excess receipts is termed angel tax. The person purchasing its shares is called the angel investor.
However, this rule will not be affective in the following cases:
(i) Shares are purchased by any venture capital undertaking (certified by SEBI) from a venture capital company or a venture capital fund
ii) Shares are purchased by a company from a class or classes of persons as may be notified by the central government.
Related: Penalties Under the Income Tax Act
The government has recently relaxed the procedure to apply for exemption of angel tax. Any eligible start-up can contact the Department of Industrial Policy & Promotion (DIPP) with supporting documents for angel tax exemption. Applications of DIPP-recognised start-ups will be forwarded to the Central Board of Direct Taxes (CBDT) along with these documents.
The CBDT will accept or decline the request within 45 days from the day of receipt of the application.
In India, start-ups are majorly funded by venture capital firms or foreign investors. Angel investors are very few and limited. Only certified start-up are exempted from angel tax. Currently, only a handful of start-ups are certified. If the angel tax rules are relaxed, more investors would be interested in investing in start-ups.
A large number of start-ups have received notices from the income tax department to pay up to 30% of their funding as angel tax. Many of the angels are receiving notices to disclose their source of income, bank statements, and other documents. This has caused a major furore among start-up founders and angel investors.
The government has announced that no coercive action will be taken to collect this tax. It has set up a committee to look into this matter. Already, some of the conditions have been relaxed for start-ups. At present, start-ups incorporated before April 2016 are eligible for angel tax exemption if their aggregate amount of paid up share capital and share premium does not exceed Rs 10 crore.
Related: Tax Planning Under MAT
The government is still working on the issues of start-ups and demands by the founders of such start-ups. The investment limit might be hiked to Rs 25 crores or Rs 45 crores from the current Rs 10 crore ceiling. These exemptions might be applicable after the start-ups submit an undertaking that the money received will not by misused. The government will also most likely certify all the ventures running for 10 years as start-ups, extending from the previous limit of seven years.
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