On one hand, the government of India is launching countless schemes and initiatives to boost the startup ecosystem. On the other hand, angel investment tax, levied at a hefty rate of 30.9% has started acting as a glitch for start-ups looking for early age investment. Earlier, the central government exempted start-ups from angel tax with few riders. However, ever since former Infosys board member Mohandas Pai, an investor for a number of startups, tweeted to finance minister Arun Jaitley about startups being harassed by the I-T department for raising capital, the concern has yet again risen to the controversy with many more and more startups calling out the unfairness. The controversial angel tax which was introduced in 2012, makes angel investment slip over 50% due to taxation.

It appears tax is still one of the issue that continues to haunt startups in the country.

Breaking Down “Angel Tax”

Angel tax is a tax levied on angel investments raised by startups. Angel investment refers to investment in equity shares of startup companies by investors.

In the union budget of 2012, the government introduced angel investment tax under section 56 (2) (viib) of the Income Tax Act, 1961. This section says that any excess consideration received by a company will be treated as the income of the start-up if it issues shares to a resident at a price which exceeds the fair market value of the shares. The section does not apply if consideration is received from venture capital companies, venture capital funds or a certain class of persons notified by the government. Thus, a startup is required to pay an angel tax at the rate of 30.9% on the capital raised in excess to its fair value.

Angel Tax: A Roadblock To Startups

Angel tax has become a cause of concern for startups as it has caused much of harassment at the hands of the tax authorities since it permits the assessing officer to judge the “Fair Market Value” of a startup and tax all investment at a valuation above this FMV as income. This rule is only applicable to angel investors from India. Venture capital firms are exempted from this tax.

Since the levy of Angel Tax there is a sharp decline in angel funds raised by startups. Angel funding has dipped from 291 in 2016 to 191 in 2017.

Hence, the government had, in 2016, as an initiative to promote startups, scrapped the so-called ‘Angel Investment Tax’ on investors providing funding to ‘startups’. According to the notification, an entity is considered to be a startup if up to five years from its incorporation/registration, it’s turnover for any financial years does not exceed more than Rs. 25 crores. Therefore, investment in every startup is not eligible for the exemption and only such startups which fulfill the conditions specified in the notification, are eligible for exemption from Angel Investment Tax. Further, the said exemption will not apply to retrospective investments.

The startups are now being forced by the IT Department to part with their portion of the capital they have raised from the investors. The notices are not just issued to the startups but also to the Angel investors under Section 68 of the Income Tax Act, 1961 on the unexplained income liable to tax. This has resulted in 40% reduction in angel investment and seed funding deals.

Most of the startups have complained that they are unfairly forced to spend their time and resources in replying to the notices issued to them by the IT Department regarding the funds they have raised from the Angel investors.

Padmaja Ruparel, President of the country’s largest angel investment grouping, Indian Angel Network told Economic Times that instead of making such rules that makes harder for the startups to raise money, the law should instead punish such persons who use startups as a way to launder money. It is also recommended that the genuine startups backed by established angel investor groups should be recognised same as the venture capitalists.

The Way Forward

Since the new union budget is only three months away, angel investors whose investments in startup gets taxed as “angel tax”, are raising concerns over this.

At one instance, the government is initiating programs like StartUp India and StandUp India to promote startups in our country, while on the other such stringent tax laws acts as a deterrent to the entire ecosystem. It’s time that the ministry strikes a balance between collecting revenue and safeguarding growth-oriented sectors of the economy.

 

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