Startups: The Saga of Angel Tax In India

Last Updated at: Jan 03, 2020
Startups: The Saga of Angel Tax In India

History of angel tax

In the year Union Budget of 2012, the then Finance Minister, Mr Pranab Mukherjee introduced a new tax into the Indian economy. This tax, which he named as angel tax, was brought to prevent the suspicious movement of funds in the market. In recent years, the Indian economy has seen many new companies capturing the market with their innovative ideas and ease of doing business. The onset of the digital era has brought in the limelight the idea of START-UPS and their increasing hold on the economy of the nation. The individuals with high net worth, foreign investors, venture investors, and almost all the people who are capable of investing have put their money into various new Startups . But since the introduction of this angel tax, angel capitalists seem to find their necks in the hold of the government, and the startups have shown a decreasing trend in their profits. 

What is an angel investment?

Angel investment is a kind of investment made by any individual, particularly in the start-ups or new companies that are still on their way to grab the market and achieve success. Such investors are termed as angel investors as they keep their eyes only on those start-ups which seem to have a promising future, and thus they invest in them with significant capital and get ownership or equity or convertible debt in return.

What is angel tax?

Angel tax in India is a distinctive tax, where any startup needs to pay a percentage of the amount received from the angel investors to the government under specific conditions if the start-up is receiving any amount which is higher than its “fair Valuation.” This excess fund is issued in shares and the share price, when the market value of the shares sold, exceeds it becomes taxable. 

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How much angel tax is payable?

All the startups which receive an amount from an external investor can be levied with a 30% tax on the fund received if the amount exceeds the company’s “fair market value.” This extra fund is considered as an additional income and becomes taxable. Angel tax is payable to all those companies in which resident individuals are interested in ploughing their money in. Any fund received by a non- resident is not considered under this section. 

What is the problem in paying angel tax?

Following are the key points which make this tax problematic:-

  • The process by which a company calculates its market value is different from the one used by the government. The government uses the Discounted Cash Flow (DCF) method to evaluate the company’s worth rather than using the Net Asset Value method (NAV). This DCF method may sometimes fail to assess the real value of a start-up, thus resulting in lowering the market value of the company. Since the angel investors invest into any company by looking at its future projections and promising potential, any clash in the entire valuation process may underestimate them and the start-ups as well.
  • The percentage of angel tax wipes away a large amount of the investment, thereby making it difficult and discouraging for the investors to provide capital for the start-ups. Thus the growth of the start-up gets affected, and the young entrepreneurs feel demotivated. 

 What next?

After the introduction of this tax, many startups received notices to pay the same. The angel investors were also asked to furnish details on their sources of income and other financial statements. The amount of the tax payable, burdened many investors with huge losses. According to a survey conducted by the community social media platforms and the Indian Private Equity and Venture Capital Association (IVCA), more than 2000 startups which had received the angel investments had been slashed with the tax notice. 

Steps taken by the Government

The Department for Promotion of Industry and Internal Trade (DPIIT) issued a notification on April 2018 for relieving the taxpayers and providing an exemption to the thriving start-up companies. As per this amendment which was done on 4th February 2019, the definitions of the startups were expanded. The following were the key points of the amendment:

  • Any company will be considered as a startup for up to ten years from the date of registration.
  • If the annual turnover of any startup does not exceed 100 crores, it will continue to function as a startup only.
  • A start-up will be exempted from paying tax if it is recognized by DPIIT and is not investing in any residential area, loans and advances, capital contribution to any other entity, shares, and securities, pieces of jewellery or any other assets in the ordinary course of the business. 
  • In addition to this, any consideration received by a start-up for shares issued to a listed company having a net worth of Rs.100 crore shall also be exempted.
  • The investor should have a minimum net worth of Rs.2 crore, and his income in the last three years should not have been less than Rs.50 lakh. 

Recently, the government announced the angel tax to be dropped in India to revive economic growth and markets. This came as a significant relief to the start-up owners and investors. While it was necessary to curb the problem of tax evasion and to keep a check on the illegal entities involved in the laundering activities, it was also required to see that genuine start-up do not face any hurdle in achieving their dreams. After all, Today’s Dream Is Tomorrow’s Reality.