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Startup Investment: Income Tax Exemptions For Angel Investors

In this article, we are going to look at the tax incentives enjoyed by investors and the criteria that makes them eligible for it.

There has been a strong wave of private investors in India owing to an open and conducive environment to startups. Investors – Indian and abroad – are looking at various valuations of Indian startups eagerly and are enthusiastic to invest even further in Indian companies. Startup Investment-Income Tax Exemptions For Angel Investors

Investors are looking forward to investing in entrepreneurial projects and startup businesses all across the country. According to an article in Dare India, experts claim that more millionaires live in Mumbai alone than in the entire west coast of US. This creates a huge opportunity for startup businesses to get investment for their projects from these wealthy individuals who are equally on the lookout for good investments. 

Investments For Starting Up

A startup not only has to go through the cumbersome process of complying with the legal requirements of incorporation, but it also has to put in a significant amount of effort to raise funds. Prior to the surfacing of venture capitalists in India, startups could raise money through limited sources such as private placements, friends and family, and loans from banks and central as well as state-level financial institutions. 

Private investors entered the startup space in early 2007-2008 and brought forward the formation of angel investing community. Some of the methods used to raise funding for a business are crowdfunding, seed funding, angel funding and Series A, B, C funding. 

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Indian Investors Can Be Angel Investors

Angel investors are the ones who invest their money in a startup when it is in its nascent stage. The Indian government acknowledged a long-awaited demand of the startup community in India on 24th May 2018 and declared that angel investors would receive a total exemption on their investments in startups. Prior to this, angel investors were taxed heavily compared to foreign and venture capital investors and a tax of more than 30% was levied on funds invested by individuals in an unlisted firm. 

Market regulator SEBI has laid down certain norms for angel investors to encourage entrepreneurship in the country and help startups arrange funds. 

Compliances For Raising Funds

Let’s look at these norms and compliances to be followed while raising funds from residents:

  • Angel investors can register themselves as Alternative Investment Funds (AIFs) which is a recently created class of pooled-in investment tool for private equity, real estate and hedge funding.
  • SEBI has restricted investment by angel investors between Rs. 50 lakhs and Rs. 5 crores. 
  • Angel investors are allowed to invest only in companies that have been incorporated in India. 
  • The funds have to be invested for a minimum period of three years in a firm and the firm in which the investment is made should not be more than three years old.
  • The firm in which the investment is made should not have a turn over of more than Rs. 25 crores annually.
  • The investee firm should not be related to a group which has a revenue of more than Rs. 300 crores. 
  • The investment made by an investor has to be minimum Rs. 25 lakhs and the corpus of the angel funds has to be at least Rs. 10 crores. 
  • As per SEBI’s norms, the sponsor or the manager is bound to have a continued interest in the angel fund and the value of the same will not be less than two and a half percent of the corpus or Rs. 50 lakhs, whichever is less. This continued interest will not be through the waiver of the management fee. 
  • The angel fund investor should not have any family connection with the investee company.
  • Any angel firm scheme can not have more than 49 investors. 
  • As an individual investor, a person should have a minimum experience of 10 years and should hold assets of at least Rs. 2 crores. 
  • The maximum period of accepting funds from investors has been increased to five years which was earlier limited to three years.
  • The angel funds are required to file a term sheet which contains material information as specified by the regulator within 10 days of the scheme being launched. 
  • There is income tax relief for those startups which have been approved by the inter-ministerial panel. The paid-up capital and share premium of such a startup should not exceed INR Rs. 10 crores after the issuance of shares. 
  • There is a requirement to fulfil specific criteria by angel investors planning to subscribe to shares in a startup. The startups are also required to obtain a report from the merchant banker which is supposed to specify the share market value of the shares as per the rules laid down by the income tax department.
  • Startups that have been incorporated on or before April 2016 can apply for an exemption from being taxed on the funds received by an entity under Section 56 of the Income Tax Act, 1961.
  • There is also a provision for 100% tax exemption for investors with a net worth of minimum Rs. 2 crores or average returned income of at least Rs. 25 lakhs in the last three financial years.
  • There is a 3-year income tax exemption available to startups that were incorporated after 1st April 2016. There is also an income tax benefit for startups for 3 out of 7 consecutive assessment years under the Income Tax Act.

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The reason for regulation in the investment sector is pointed in two directions. On the one hand, it protects the rights of the founders from losing control over their start-up and being gobbled up by the vesting powers of an investor. On the other hand it also ensures that the investor’s money is not being mishandled and is being put to good use as per the pitch that got them the investment in the first place. So it is always important to be aware of the regulations that lubricate the dynamics of this sector so that all stakeholders play on the same level playing field. If you have any other queries with regards to legal or regulatory compliances, get in touch with us and we will ensure that you receive the appropriate assistance for your requirements.

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