Angel tax needs more predictability and direction
There has been more heartburn about Angel tax in southern India than any other conceivable economic issue! Despite the statistic that 90 % of the startup ideas don’t make ‘that ‘cut at the altar, every idea (read startup) deserves a fair chance. Tax treatment is at the heart of it. Most startups seek angel’s (people who make the first substantial investment before the big investors step in). Most angels invest at a valuation that is higher than fair valuation because there an element of good will, courage and sacrifice that is considered over and above what numbers say. The said qualitative elements need to be respected because startup promoters sink in a lot of intellectual capital, take risks to create a company that will create jobs in the future and finally change conventional thinking driven by technology (in most cases).
Startups need protection, encouragement and capital to fly. While most of it is churned by the ecosystem, it is the angel tax that makes it cringeworthy. Angel tax is levied when a privately held company raises funds at a rate higher than its “fair valuation”, usually determined by the discounted cash flow method. Currently, India levies around 31% angel tax. The tax is levied on the differential between fair valuation and actual valuation. It was introduced in the Pranab Mukherjee budget of 2012 in a bid to curb money laundering via small companies. However, over the years, it has driven up regulatory and monetary pressure on budding firms, threatening their survival.
On the contrary, countries like Singapore help start-ups by reducing corporate taxes, relaxing compliances, reducing the rate of TDS and keeping compliance work investor friendly. They have created an ecosystem that fosters ideation and enterprise. Over the last 7 years India has lost many a startups to Singapore. Some startups that need to be closer to their customers have stayed back but have grown through challenges thrown by the tax regime and the compliance officers. The migration of start ups and most importantly the start up ideators to countries outside India has delivered a double blow - opportunity and talent. This needed to be arrested
The government over the last 5-7 years introduced incremental steps. Startup recognition went up from 7 years to 10 years, labour laws were diluted, 3-year tax holiday was given, easy access to funds was provided etc. etc. While most steps are start up friendly the angel tax is draconian. In the last budget the Finance minister has relaxed the angel tax applicability a bit more. The government has partially addressed a long-standing challenge on the angel tax for India’s startup industry. Startups and investors who file requisite declarations will not face additional scrutiny related to angel tax as indicated by the FM in her speech of July 5, 2019. Startups and investors filing returns will not be subjected to scrutiny for angel tax. They will not be subjected to any scrutiny on valuation of share premium. It took a lot of campaigning and promotion before this step has been realized.
So, no scrutiny on startups that provide requisite declaration of valuation documents and financial statements (for Angel Tax). e-Verification of identity is all that's needed! The finance minister has indicated that there will be no scrutiny. This should now decisively address the 3 challenges for India's startup sector - high credit cost, lack of adequate and timely funding and regulatory bottlenecks.
Lot of marquee Indian Startups who went on to raise venture capital chose to incorporate their business outside India and register their headquarters in the US, Singapore, Mauritius, and other places. For example. Flipkart, Practo, Grofers, Druva, InMobi etc. operate within India but are headquartered outside the country. Startups like Capillary Technologies, Near, Mobikon, U2opia Mobile and Ton Bo imaging are examples of Indian star ups that migrated to Singapore
Better late than never as they say. The angel tax situation seems to have been addressed to a great extent and this should go in creating a conducive ecosystems for startups to operate in India because India is and will continue to be the largest consumer market for many Startups that are essentially trying to eliminate the B out of the B to B to C models. More needs to be done but angel tax directive is a step in the right direction