Angel Tax
Several startups are receiving income tax notice on angel funding they have a couple of years ago.
Table of Contents
What is Angel Tax?
Angel Tax refers to income tax payable on capital raised by closely held companies. It is pertinent to note that this income tax is not on income rather on the amount of money has been put in as capital into the business.
Genesis:
This was introduced during Budget of 2012 by Finance Minister Pranab Mukherjee to stop the laundering of funds. Eventually, its angel tax since this had wide ramification on angel investments in startups.
Provision of Income Tax Act:
The following anti-abuse provisions were introduced on 1st April 2012.
Section 56(2)(viib): Closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares will be charged to tax:
Challenges on the part of Startup: Firstly, Startup Company have to justify the share premium even in the absence of an indication of unaccounted money & secondly, the means provided to justify the issue price is too limited either Book value method (BV) or Discounted Free Cash Flow method (DCF)
Section 68: Unexplained source of cash credit: This is impacting Startups
Section 69: Unexplained source of investments: This is impacting investors
Any exemption allowed?
DIPP has issued a notification on the procedure for startups to avail tax benefits in April 2018. A Startup is required to submit approval form Inter-Ministerial Board (IMB) for claiming exemption u/s 80-IAC of income tax act. It prescribes the conditions for exemption to Startups and investors on the fulfillment of 3 conditions:
(1) Criteria for Startup: Aggregate paid-up share capital & share premium does not exceed Rs 10 Crores,
(2) Valuation report from Category-I Merchant banker specifying the fair market value (FMV), and
(3) Criteria for Investor: Either
(i) Average returned income is Rs 25 Lakhs or more during the preceding three financial years, or
(ii) The net worth of Rs 2 Crore or more as on the last date of preceding the financial year
Challenges:
- Startups: Startups should get easy access to funding their growth and further breed entrepreneurship leading to job creation and economic growth. But given the provision of law, only a few can comply and enroll for exemption.
- Investors: Investors would be resistant to share their copy of returned income and balance sheet with the startup, especially an overseas one.
Conclusions:
Every day the rule of the game is changing for startups – notifications are being issued and then withdrawn. That’s not the only challenge from policy perspectives. Rules & regulations are subjective in nature, the outcome of an assessment depends on the Assessing Officer (AO). AO disputing the assumptions of independent valuation and issuing notices left & right to Startup, Investors, Valuation Professionals resulting in chaos in the entire ecosystem.
In the short term, it might bring a small chunk of revenues but in the long term, this would tarnish the image of the country before the global community.
It’s high time that we come with a concrete tax framework, not a lip service. People are more than happy to comply with the regulation.
Also read:
- Investor Pitch Deck
- Startup Pitch Deck – 15 important points to get funded
- STARTUP PITCH DECK MISTAKES – COMMON MISTAKES
- Track Key Investors Metrics for your Startup
- Pitch Deck – Success Stories
