Angel Tax … the word itself is so complex. While, on one hand our prime minister was promoting Startups in the young with young ideas, on the other hand those entrepreneurs were fighting a complex tax structure. This story is of the whole Angel Tax system, how and why it came, all the aspects of it and what form it reached finally.
Angel Investors and Angel Tax
For understanding Angel Tax we need to first understand the concept of Angel Investors. As the word suggests … its like an ANGEL. Angel investors are informal investors like private investors, fundraisers, and business angels. They invest in Startup companies by securing Equity in the company, not with a profit motive but with the aim of boosting innovative ideas brought up the youngsters. For that purpose, they bring lucrative offers and as a result there has been abundant angel investment in Indian startup companies as well. Well … where there is an Investment there is a Tax.
It was thought that the money being pumped into Startups will lead to huge money laundering by inflating and then buying shares at higher prices by the Investors. It was feared that if India goes towards becoming an Angel Tax Heaven it will further increase already high level of Black Money levels in the country as huge investors will just invest off their back money in startups and from there it will be very difficult to track the source of money as seldom any startups maintains proper books and accounts. So, in 2012 Budget the Angel Tax was brought in to curb all these possibilities through 2012 Finance Act by the then finance minister PRANAB MUKHERJEE.
Legal Aspect and Global point of view
From the legal point of view, Section 56(2)(VII B) of the Income Tax Act of 1961 (applicable for startup companies), the Equity Shares of closely held company and further taken up by investors will be amount to that much Value of shares which is above the ‘fair value’ of shares in the market and this fair value will be calculated by Government Authorities. These funds will come under ‘Income from Other sources’ and and 30% Tax will be charged upon it (and Cess levied).
When taken over the global scenario, it was found that most of the countries were not just promoting Angel Tax but had also built up many huge Startup Empires. In Europe and Australia, there were actually Incentives for Angle Investments. China too was quite liberal regarding this thing and many firms like Baidu, Tencent, and Alibaba reached global heights with the help of this only. So, India was on quite contrary lines as compared to its global counterparts.
The Dilemma for Startups
Now … the problem arose that in aim of curbing black money, it were the Startups which became Scapegoats. First of all, there is a difference between the method of calculation of fair value by Startups and Government tax department. Government authorities often value startups subjectively on the basis of discounted cash flows, without taking into consideration many factors such as Goodwill, which leads them to overestimating the amount due on the part of Startup company, eventually they being have to pay much higher amount.
Also, not all startups receive money from black sources, some are genuine investors as well. Also it is no surprise that startups struggle a lot for raising money and for them to pay out 30% of whatever they got was a huge burden. It was leading to the growth of startups in India reaching a standstill as many possible investors were shying away from investing into the Startups. For new startups, the angel investors are a major source of revenue and if the source is being curbed the startups will become Handicapped. Cases also occurred where young Entrepreneurs were being questioned by tax authorities over the sources of money invested in their startup. All the message of START UP INDIA … STAND UP INDIA seemed a dismal claim now.
Reforms in the Regard
The government had it very clear now, that by seeking tax on Angel Investments they are only hitting the Nail on the Coffin of India’s Startup future. First of all, to promote Startups the range of startups was increased. Now, a company will be regarded as Startup till 10 years (earlier it was 7 years) and if its net worth is less than 100 crore (earlier it was 25 crore). After that, certain conditions were laid down after fulfillment of which, Startups will be exempted from paying the Angel Tax.
- The paid-up capital of the company after issuance of shares, along with premium share, should not exceed 10 crore;
- The government has made it mandatory to get the Valuation done with the assistance of a certified merchant banker and companies can’t use their own methodologies for it.
- The person making an investment should have a minimum net worth value of 2 crores, and his annual income for the last 3 years should not be at least 50 lakh.
Conclusion : A long way for Startups
So … this was the story of Angel Tax in India. The rollercoaster ride has though finally reached a position, which can’t be called Harsh upon the Startups. There is a certain minimum level of requirements and Audit which has to be done in order to get exempted from paying Angel Tax. In my opinion, it was the right way through, kind of going into Middle Route, so that Startup Industry also remains alive and some Assurance can also be felt regarding the legality of funds being infused in the Startup industry. But … still the experts say that it is a long way to go for Startups in India as not all especially small ones will be able to fulfill the requirements easily. So … lets hope that government keeps on addressing the needs of demands of the Startup industry as per the latest norms without the legal boundary being breached. This was the ANGEL TAX story from my side.
JAI HIND
ARUNESH SINHA
References :
- Angel Tax – Everything you need to know about it, by Navdeep Kaur| 17 Apr 2020 https://corpbiz.io/learning/angel-tax-in-india-everything-you-need-to-know-about-it/
- Everything you need to know about India’s Angel Tax and why it worries startups, By Rohit James|2nd Feb 2018 https://yourstory.com/2018/02/angel-tax-101-and-why-you-should-care?utm_pageloadtype=scroll
