I. Introduction to Angel Tax??
Angel Tax is a levy imposed on capital raised by unlisted companies through share issuance when the share price exceeds the fair market value.?In the Finance Act of 2012 to prevent money laundering, it has significant implications for Indian start-ups and angel investors.?
Let’s understand this concept with an example: Let’s say, your company has a fair market value of INR 6 crores. And you have received investment of INR 10 crores from an angel investor against subscription of shares of your company.??
Since the consideration is more than your fair value, the excess will be considered premium and the same will be subject to tax i.e., INR 4 crores will be charged to tax @30.9%.?
II. Applicability of Angel Tax?
Angel Tax is applicable only to resident investors in India under Section 56(2)(viib) of the Income Tax Act, 1961. However, w.e.f 01st April 2024, it shall be applicable to non-residents too. This section mandates that any premium received by the company over the fair market value of its shares is considered income from other sources and taxed accordingly.?
- Tax Rate: The tax is levied at a rate of 30.9%, which includes cess and surcharge.?
- Entities Covered: Primarily unlisted companies receiving investment from angel investors.?
- Companies recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) under the startup India initiative are exempt from this tax under certain conditions.?
- Domestic companies receiving fund from venture capital fund?
III. Relevant Rules and Regulations?
- Section 56(2)(viib)
:
This section details the provisions for taxing the premium received by unlisted companies on shares issued to investors.?
- Rule 11UA
:
This rule specifies the method for determining the fair market value of shares.?
- DPIIT Notification
:
Startups registered with DPIIT and meeting specific criteria are exempt from angel tax. The criteria include factors like age of the startup (not more than 10 years), turnover (not exceeding INR 100 crore), and the nature of business (focused on innovation, development, deployment, or commercialization of new products, processes, or services driven by technology or intellectual property).?
IV. Exemption from Angel Tax?
To avail of the exemption from Angel Tax, a startup must:?
- Be recognized by DPIIT. (Department for Promotion of Industry & Internal Trade)?
- Not be investing in specified assets like real estate (buildings or land), loans and advances, capital contribution to other entities, shares and securities, vehicles exceeding INR 10 lakhs worth, and jewellery.??
- Have a paid-up share capital and share premium after the proposed issue of shares not exceeding INR 25 crore (recently increased to INR 50 crore in some cases).?
In computing the capital, the amount of capital held by non-resident and venture capital funds shall be excluded.?
The Startup shall file Form 2 with the DIPP declaring the fulfilment of the above conditions, which shall be further forwarded by DIPP to the CBDT. In case of any non-compliance, the exemption will be revoked with retrospective effect.?
V. Latest News on Angel Tax?
The government has been proactive in addressing concerns related to Angel Tax, particularly for startups. Recent updates include:?
- June 2024: DPIIT secretary Rajesh Kumar Singh confirmed that the department has requested for removal angel tax for startups.?
- May 2023: The government announced that investments in startups by Non-Residents and certain specified categories investors would be exempt from Angel Tax, aiming to boost foreign investment in the Indian startup ecosystem. (CBDT via notification numbers 29 and 30 of 2023 dated 24 May 2023)?
VI. Statistics on Angel Tax?
- Over 10.8K DPIIT-recognized startups have applied for the angel tax exemption so far.?
- A total of 8,066 startups have been exempted from angel tax till September 26, 2023.?
- The latest survey over Angel Tax has found that 70% of Indian startups that raised capital have received one or more notices from the Income-Tax (I-T) department.?
VII. Impact of Angel tax:?
- Tax on non-residents: Government has notified 21 countries, including USA, UK, Australi and France, from where non-residents' investments in startups will not be subjected to angel tax. However, the exemption is only available for notified entities such as Securities and Exchange Board of India (SEBI) registered Category-I foreign portfolio investor, Endowment funds associated with a university, hospitals or charities, Pension funds created or established under the law of the foreign country or specified territory, Broad-based pooled investment vehicles or funds with more than 50 investors (not being a hedge fund or fund which employs diverse or complex trading strategies). It also does not include non-resident investors incorporated in Singapore, Mauritius, Netherlands and other countries which are active in the FDI space.?
- Valuations conundrum: Under the Foreign Exchange Management Act (FEMA), companies are prohibited from issuing equity instruments below the Fair Market Value (FMV). Typically, non-resident investors prefer to subscribe to shares at premium prices to account for valuation adjustments, anti-dilution protections, and other financial considerations. However, with the applicability of angel tax, these investors must now agree to subscribe to shares at their FMV. This requirement poses challenges, as it limits the flexibility of non-resident investors to negotiate premium pricing, potentially impacting the attractiveness of investments and the overall valuation of start-ups.?
- Broad Prohibition on Investments: The prohibition on investing in ‘shares and securities’ are so broad that even passive investments in mutual funds can disqualify a startup from claiming angel tax exemption.?This restriction limits the financial strategies a startup can employ to maximize its earnings, thereby facing potential growth and innovation.?
- Strategic Acquisitions and Business Diversification: Startups engaging in strategic acquisitions or incorporating subsidiaries to scale their business are disqualified from angel tax exemption. It prevents startups from undertaking necessary activities that are crucial for scaling, innovation, and market competitiveness.?
- Restrictions on Loans and Advances: Loans and advances given to employees, a common practice in business operations, can lead to disqualification if lending money is not a substantial part of the startup's business. It hinders operational flexibility and employee welfare measures, affecting overall employee satisfaction and productivity.?
- Compliance Challenges: Very early-stage startups (within the first 6 months to 1 year) can comply with exemption conditions, but this is impractical for more established startups.?
- Sector-specific Issues: Companies in sectors like defense, ed-tech, manufacturing, and fintech often require strategic partnerships, making them ineligible for exemptions despite their startup status.?
Angel Tax, while introduced with the intention of curbing money laundering, has had significant implications for the startup ecosystem in India. The government has been responsive to the concerns raised by the startup community, introducing various exemptions and reforms to ease the burden of this tax. As the Indian startup ecosystem continues to grow, ongoing dialogue between policymakers and industry stakeholders will be crucial to ensuring that tax policies support innovation and investment.?
Disclaimer: The content provided in this article is intended solely for educational and informational purposes. The information contained herein is based on publicly available data, research, and the author's analysis as of the date of publication. While efforts have been made to ensure the accuracy and reliability of the information, the author makes no representations or warranties, express or implied, regarding the completeness, accuracy, or suitability of the information for any particular purpose.
