ABOLITION OF ANGEL TAX
Alpha Partners
Recognised Indian corporate commercial law firm based in Delhi NCR and Dubai
By Nivedita Guliani and Avneesh Bahuguna
Introduction
?
In a landmark move, the Indian government has announced the abolition of the controversial 'Angel Tax' in the 2024-25 Union Budget. This decision, unveiled by the Finance Minister, aims to invigorate the country's startup landscape and foster innovation.
?
Overview and Understanding
?
Angel Tax was introduced in India through the Finance Act of 2012. Under Section 56(2)(viib) of the Income Tax Act, 1961 (“IT Act”) if a company issues shares at a price higher than its fair market value, the excess amount is treated as income from other sources and taxed accordingly to the company. This tax is known as angel tax (“Angel Tax”). The Angel tax was introduced in 2012 in the IT Act with the intention of preventing money laundering and curb the practice of issuing shares at inflated prices. The term "angel" refers to angel investors, who typically provide capital to startups.
?
If a company issues shares at a price higher than the Fair Market Value (“FMV”) of those shares, the difference between the issue price and the FMV is considered as income. This excess amount is treated as "Income from Other Sources" under Section 56(2)(viib) of the IT Act and is taxed at the corporate tax rate, which is currently around 30% for most companies in India.
?
The calculation of Angel Tax involves determining the FMV of the shares. The FMV can be calculated using the methods prescribed under the Income Tax Act, 1961.
?
Implications of Angel Tax
?
The implications of Angel Tax have been profound for both startups and investors. For startups, the financial burden of additional tax liabilities is substantial, especially in their formative years when funds are crucial for growth and development. This tax has also discouraged many angel investors from backing startups, owing to the potential tax implications and the subsequent reduction in their overall returns on investment. Moreover, the process of determining FMV is often complex and subject to intense scrutiny by tax authorities, leading to prolonged disputes and legal battles.
?
Abolition and its impact on startups
?
In 2019, the Indian government relaxed the norms for startups as recognized by the Department for Promotion of Industry and Internal Trade (DPIIT). The startups are exempted from Angel Tax if the aggregate amount of paid-up share capital and share premium does not exceed INR 25,00,00,000 (Indian Rupees Twenty Five Crores only) approximately $3,300,000 (United State Dollars Three Million and Three Hundred Thousand only)[1].? The startups were eligible for exemptions and various tax benefits such as tax holiday for a period of consecutive 3 years, if they are registered with the DPIIT[2]. However, the lower prescribed threshold limits were easily crossed by start-ups.
?
These relaxations were aimed to boost entrepreneurship and encourage investments in startups. With the removal of the tax, it will allow corporates, especially startups, to focus more on their core business activities and growth. This change is likely to lead to a surge in investments, thereby propelling innovation and entrepreneurship in India.
Conclusion
?
The abolition of Angel Tax in India's 2024-25 Union Budget marks a pivotal moment in the country's business ecosystem. This decision reflects the government's commitment to fostering innovation, encouraging entrepreneurship, and attracting investments in the business sector.
?
However, it's important to note that while the Angel Tax has been abolished, other regulatory mechanisms like the Prevention of Money Laundering Act, 2002, remain in place to prevent potential misuse. The government will need to strike a balance between encouraging legitimate investments and preventing illicit financial activities. The success of this policy change will depend not only on the increased influx of investments but also on how effectively the entities utilize this opportunity to drive innovation and create value.