For the growing startups in India, angel funding is nothing less than a foundation stone upon which their future development plans take shape. Most of the people, who dream to become an entrepreneur, require angel investments at some point of time to thrive and drive their startup towards success.
There was a time when the Indian entrepreneurs had to put their dream of starting a company in the cold baggage because of lack of funds. In the last 10 years, the startup ecosystem in India has flourished a great deal and it is buzzing like never before. The year 2018 has been quite significant in India’s startup history because according to the National Association of Software and Services Companies (NASSCOM), a total of 1200 new startups were added. The number is quite highest in the in a year in the Indian startup history.
The phenomenal rise in the number of startups in India can be attributed to various factors. The Indian government has left no stone unturned to fulfill the entrepreneurial dream of the people. For this purpose, they have launched two prominent flagship programs, ‘Make in India’ and ‘Startup India’. The government has also eased out norms that have gone a long way to help the individuals start their companies. However, in spite of launching plenty of schemes for the startups, one thing that is giving sleepless nights to the startups is the angel tax.
All You Want to Know About Angel Tax in India
Angel tax is essentially a kind of tax that is imposed on the investments, which is made by the external investors in startup companies in India. It is important to note that not all investments are taxed. A tax rate of 30.9% is levied on the amount that exceeds the fair market value of the startups. The investments received by the startups are considered as the ‘income from other sources’ and hence taxed according to the Section 56 (2) (vii b) under the Income Tax Act 1961 with reference to the Finance Act of 2013.
Some of the prominent facts about the angel tax in India are as follows:
- Angel tax was introduced in India in the year 2002 with the main objective of preventing money laundering and putting a lid on the illicit practices.
- In the Union Budget of 2012, then finance minister, Pranab Mukherjee, proposed angel tax to curb laundering of funds.
- The fair value of the startups is determined by the income tax authorities after the angel investors have made an investment in the companies.
Why Angel Tax was introduced in India?
There was a specific reason behind the introduction of angel tax. A few years back, a practice was developed, where some of the closely held companies could bring an undisclosed amount of the money by issuing the shares at a high premium that was above fair value share of the company. A closely held company is basically a company where most of the shares are in the possession of the small percentage of the shareholders and not available to the outsiders. It was alleged that the people with the black money used to invest in these companies. In order to curb the practice of converting black money into white, the then Finance Minister of India, Mr. Pranab Mukherjee introduced angel tax in India in the Union Budget of 2012.
Impact of Angel Tax on Startups in India
Startups, especially in the early stage, require monetary assistance to keep the business afloat in the market where the competition is quite stiff and most importantly run their business operations smoothly. What the angel tax does is that the high level of the taxation limit discourages the angel investors to come forward and provide monetary assistance to the startups in India. When the startups receive notice from the income tax department, then they are required to provide other details also like income source, bank account statement and other prominent data. Furthermore, if the share is issued to the investor, then it has to be decided by the income tax authorities whether it exceeds the fair value or not. The startup industry demands that the valuation of the fair value, the government must consider using the Discounted Cash Flow (DCF) method instead of the prevailing Net Asset Value (NAV) method.
Angel Tax Exemption Relief to the Startups
Taking into the account the issues faced by the startups due to the angel tax, the government provided relief to them by making an amendment in the Union Budget 2018. Under Section 56 of the Income Tax Act, if the funding from the investors does not exceed Rs 10 crore, then the startups are eligible for the angel tax exemption. However, there one important point of consideration that must be noticed for the purpose of getting an exemption. The startups are required to get approval from the inter-ministerial board and valuation certification by the merchant banker. Moreover, an exemption will only be liable if an investor has a minimum net worth of Rs 2 crore and the average returned income of Rs 25 lakhs for the preceding three financial years.
The Last Words
It is important that the government must look into the problems faced by the startups with regard to the angel tax in India to ensure the smooth functioning of the business operations. There should be some policies or plans to promote the positive startup culture in the country and safeguarding their growth.