Explore the new angel tax exemptions extended to 21 countries, with details on valuation, its effect on investment, and exceptions, such as Mauritius.
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The Finance Ministry of India has recently announced that investments from non-residents, originating from 21 countries such as the United Kingdom, Germany, France, and the United States, into Indian startups that are privately owned will not be subjected to the angel tax. The angel tax is a financial obligation imposed on unlisted companies in India when they receive investments from angel investors. The tax applies to the portion of the investment that surpasses the fair market value of the shares issued by the company.
However, it should be noted that this announcement does not apply to certain countries. Specifically, investors from the Netherlands, Mauritius, Singapore, Cyprus, the United Arab Emirates, and the Cayman Islands are not included in this exemption. However, some experts believe that the exclusion of funds from countries such as the Netherlands, Mauritius, Singapore, Cyprus, the United Arab Emirates, and the Cayman Islands could potentially restrict the benefits of this recent policy change for Indian startups.
Know More About CBDT proposes changes to Rule 11UA in respect of ANGEL TAX
It’s important to note that the government had previously broadened the scope of the angel tax to include investments from foreign investors. During the most recent union budget, the government extended the angel tax obligation to overseas investments in privately-held companies, barring startups recognized by the Department for Promotion of Industry and Internal Trade. Since this change, both the startup sector and the venture capital industry have been advocating for tax exemptions for certain categories of overseas investors.
Experts have previously stated that startups that receive tax notices are obligated to pay a tax equivalent to 25% of the investment they raised. If they violate the exemption conditions, they would face penalties twice the amount of the tax. To have a better understanding of ‘Talk to CA‘ The Central Board of Direct Taxes (CBDT) recently delineated the categories of investors that will not be subject to the angel tax. These excluded groups include entities registered with the Securities and Exchange Board of India (SEBI) as Category-I Foreign Portfolio Investors, endowment funds, pension funds, and broad-based pooled investment vehicles that are residents of 21 designated countries. Last week, the government suggested numerous amendments to the tax imposed on angel investors in unlisted entities, which included the expansion of valuation methodologies.
Drawbacks of Angel Tax
Here are some key drawbacks:
- It is applicable only to startups funded by resident Indians.
- Startups receiving investments from venture capital and non-resident investors are not eligible for angel tax deduction.
- It leads to startups losing a substantial portion of their investment as they are required to pay a significant amount in taxes.
Angel Tax Exemption
As mentioned earlier, the implementation of angel tax leads to a significant loss of investment for startups. This loss is particularly burdensome during the early stages of a startup when funds are scarce. The inclusion of this tax in the amendment has faced widespread criticism from investors, entrepreneurs, and industry analysts.
In response to the pleas made by startups, the Indian Government introduced some relaxations in the 2019 Union budget. According to this budget, startups that are registered under the DPIIT (Department for Promotion of Industry and Internal Trade) are exempt from this tax.
However, in order to be eligible for DPIIT, startups must submit an application along with the necessary documents to the CBDT (Central Board of Direct Taxes). Once approved by the CBDT, they will be granted exemption from paying angel tax.
In addition to this, startups must fulfill certain criteria to file the required declaration and returns for angel tax exemption. Here is a brief overview of those criteria:
After issuing shares, the total paid-up capital and share premium of the startup should not exceed ₹ 25 crore.
According to Rule 11 UA (2)(b) of the Income Tax Act of 1961, the fair market value of the startup must be evaluated by a merchant banker.
The calculation for tax exemption does not include the amount raised from venture capital firms, NRIs, and certain other companies. Moreover, the startup’s annual turnover should not exceed ₹ 100 crore in any of the previous fiscal years.
As per the income tax notification, angel investors can receive a 100% tax exemption on investments made in startups with higher fair market value. However, to avail of this exemption, angel investors must have an average income not exceeding ₹ 25 lakh and a net worth of ₹ 2 crore in the previous 3 fiscal years.
Startups can enjoy a tax holiday for three consecutive years starting from the date of incorporation. During this period, they are exempt from paying taxes.
Angel Tax Rate in India
India follows a well-organised tax system that incorporates proportional and progressive taxation, which varies based on income and various other criteria. Within this system, angel tax is imposed at a significant rate of 30.9% on investments obtained by startups that exceed their fair market value. As a result, new businesses in search of funding from investors are obligated to pay angel tax to the Income Tax Department.
Angel Tax Example
Startups have faced numerous challenges due to the existence of angel tax, resulting in a significant portion of their investment being lost to tax obligations. To illustrate this, let’s consider the following scenario:
Imagine your startup secures an investment of ₹ 50 crore by issuing 1 lakh shares to an Indian investor at a price of ₹ 5000 per share. The fair market value of each share is ₹ 2000, which values the total shares at ₹ 20 crore. Consequently, the startup is liable to pay angel tax on the excess of the fair market value, amounting to ₹ 30 crore (₹ 50 crore – ₹ 20 crore). As a result, the tax due on this transaction would be ₹ 9.27 crore (calculated as 30.9% of ₹ 30 crore).
How Will Vakilsearch CA Help You Here?
Navigating through the complexities of the angel tax and its implications for your startup can indeed be a challenge. But don’t worry, that’s why we, at Vakilsearch, are here to support you! As a tax expert, let me outline the ways we can assist you:
- Efficient Tax Management: We’ll help you sail smoothly through the sea of tax laws and stay on top of compliance. Our experts ensure your tax returns are filed accurately and on time, highlighting any exemptions that you’re entitled to.
- Expert Valuation Services: The angel tax comes into play when investments exceed the fair market value of your shares. Our team of experts will help you accurately evaluate your startup’s shares, playing a crucial role in reducing your tax liability.
- Strategic Financial Advice: Need advice on funding and investment strategies? We’ve got you covered! We can assist you in structuring your funding in a way that minimizes tax obligations while maximizing growth potential.
- Strong Representation: If you ever find your startup under the scrutiny of a tax notice or audit, our experts will represent your case before the tax authorities, defending your position robustly and effectively.
- Liaising with Regulatory Bodies: We maintain active communication with regulatory authorities such as the CBDT, SEBI, and the Department for Promotion of Industry and Internal Trade. This helps us keep you updated about any new developments that could affect your business operations.
- International Tax Law Guidance: For startups with international investments, our team, well-versed in international tax laws, will guide you through tax implications and treaty benefits. We’ll help you avoid the pitfalls of double taxation and take advantage of exemptions across different jurisdictions.
At Vakilsearch, we’re committed to helping you manage your finances effectively, ensuring you stay tax-compliant while driving your business towards growth and success.
FAQ
What is Angel Tax?
Startups that receive investments exceeding their fair market value are subject to angel tax, which is imposed at a high rate of 30.9%. These new businesses, when seeking funding from investors, are required to make angel tax payments to the Income Tax Department.
Who has to pay Angel Tax?
Angel tax is applicable to startups that receive funding from resident Indian investors. However, startups that secure investments from venture capital firms and non-resident investors are not eligible for angel tax deduction.
Why was it introduced?
The introduction of the provision called 'angel tax' in 2012 aimed to discourage the generation and utilisation of undisclosed funds through investments in privately held companies.
