Startups Desire A Reduction In The Angel Tax.

One of the most contentious features of this year’s Union Budget has been the expansion of the scope of the angel tax to include funds generated from non-resident investors. The income tax authorities have used a provision introduced in 2012 with the original goal of taxing unaccounted money and finding its way back into the system through share issuances at unusual premiums to raise demands on startups raising capital at valuations previously unheard of in traditional business models.

Following the suite, which says startups registered with DPIIT are exempt from the rule as long as total investment, including angel investor capital, does not exceed Rs 25 crore, the startup industry is asking the finance ministry to eliminate, or at least raise, the Rs 25-crore barrier that exempts it from the so-called angel tax. According to the industry, only a tiny fraction of companies will be able to fulfil this threshold. The Centre is gathering information from various stakeholders and will issue a full explanation of angel tax in the coming days.

Among other things, startups discussed this problem in a conference last week with the finance ministry and DPIIT. Aside from that, they were alarmed by the proposal to subject overseas investors to angel taxation.

According to persons familiar with the topics, the industry has also requested freedom to invest extra cash in the money market and liquid instruments. According to Section 56(2)(vii)(b) of the Income Tax Act, if any closely held firm issues shares at a price greater than fair market value as calculated using the authorised technique, the difference is taxed as income from other sources. Section 56(2) (vii)(b) states that any sum raised by a startup in excess of its fair market value is considered income from other sources and is taxed at 30%.

If the startup’s total paid-up share capital and share premium after the issuing of shares does not exceed INR 25 crore, this tax is not due. This threshold was last amended in 2019 when it was increased from Rs 10 crore to Rs 20 crore.

What is angel tax?

The clause was placed in place to deter money laundering through exaggerated values, but it has had an impact on various startup and angel investments, thus the name angel tax. 

Concerns.

Industry claims that the threshold is too low, citing rising input costs and wage inflation. The limitation discourages entrepreneurs from registering with DPIIT. Given the elemental nature of startups, there is a need for ongoing investment in product/process innovation, according to the depiction. Furthermore, companies expanding their operations to become pan-India (or worldwide) would require significant resources to put up the logistical infrastructure.

The Rs 25-crore limit did not apply to non-resident shares, venture capital firms registered as category I alternate investment funds (AIFs), or designated corporations. The Finance Bill 2023 repealed this exception and wants to subject foreign investors to the angel tax, which previously only applied to Indian nationals and funds that were not registered as alternate investment funds. Foreign investment remains an important source of finance for the startup ecosystem and investors.

In addition, India will look into the valuation guidelines for the so-called ‘angel tax’ on investments in startups by foreign investors. According to experts, this might frighten away growth capital and lead to valuation conflicts because various procedures are mandated under different legislation. The idea is that every business value is an estimate based on many future assumptions that may or may not be realised.

Conclusion.

The government has said that businesses registered with the DPIIT would continue to benefit from relief; nevertheless, for many unrecognised firms that are mostly foreign-financed, the provision may add to funding hurdles in an already challenging climate. Some experts believe that this proposed modification has the potential to make life even more difficult for cash-strapped entrepreneurs, particularly given that we are now in the midst of a financial winter.