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Crazy Idea: Budget 2012 Asks Startups To Pay Tax On Angel Investments

18 March, 2012

The UPA government has suggested a measure in the Union Budget 2012 which will kill angel investing and give birth to still-born startups in India. The Budget has introduced a new clause which will treat all individual investments (which will include genuine angel money also) in a company as “income from other sources”, and they will be subject to a tax of 30% at the hands of the companies (including all genuine startups).

The government also brings in a concept of fair market value to calculate this taxable income. So the consideration received in excess of face value and also the fair market value will be considered for taxation. The problem is fair market value has to be “substantiated” to the satisfaction of assessing officer who is not an expert on valuation of especially emerging businesses (how will they value a Facebook or Twitter or an InMobi?).

The clause is reproduced from the Budget documents here:

Section 56(2) provides for the specific category of incomes that shall be chargeable to income-tax under the head “Income from other sources”.

It is proposed to insert a new clause in section 56(2).  The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to incometax under the head “Income from other sources. However, this provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.

Further, it is also proposed to provide the company an opportunity to substantiate its claim regarding the fair market value.

Accordingly, it is proposed that the fair market value of the shares shall be the higher of the value –

(i) as may be determined in accordance with the method as may be prescribed; or

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.

[Page 8-9 of memorandum (PDF doc)]

The government takes pride in the fact that it has exempted venture capital investments from this ambit, and has only brought individual investments in the tax net. This shows government’s clear lack of knowledge of investment value chain in startups. 

Angel investment or investments from individuals such as friends and families are at a very early stage of the company where VC funds usually do not come in. Only after the company sees a significant traction or the proof of concept is established, an early stage VC fund will invest in a startup. So the investment from “persons” comes in at the earliest stage.

A startup will not get institutional money at a very early stage, so that gap is filled by high net worth individuals and successfull entrepreneurs who will provide the capital to startups as their personal investments. From a startup’s point of view, there is no difference between individual capital  or institutional capital, it’s just the startup capital for them. They need that to establish the business and grow to a stage where it can absorb insititutional capital. And when the institutional capital come in, the individual investors usually exit. This is the way investment value chain works, to which the government seems to be closing their eyes.

So there is a fundamental divergence of views between the government and the investment industry in treating the early stage investment. The government sees only VC funds as genuine investors in startups while it sees individual investors suspiciously as if they are not genuine partners in building a startup. The point is why should any form of investment be distinguished from the other? An investment is an investment whether it’s from an individual or a company or a venture capital fund. 

There can’t be a more regressive step than this, and it clearly shows how backward is our establishment in understanding new investment models.

As a first step, all industry bodies and angel networks need to convince the establishment that angel or an individual investment in a startup is an asset class just like venture capital. If the government listens and appreciates this, the startup industry can be saved and lakhs of jobs generated by these startups can be protected. Finally, one last point. Privately held companies generate many more jobs than listed enterprises and contribute to India’s GDP growth, so why would they be penalised? They should be encouraged instead.


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Crazy Idea: Budget 2012 Asks Startups To Pay Tax On Angel Investments

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14 Comments
Lakshmi . 6 years ago

It is not good for government include angel investors in tax bracket. Government instead of encouraging start ups and it is discourages them.!

Regards

Lakshmi

http://www.ApnaBus.in

Vinayak Joshi . 6 years ago

This is a step calculated to encourage corruption. The tax amount will be calculated based on the investment value and the fair market value. The fair market value will be decided by the assessing officer (as per Section 56(2) ii). So the assessing officer would basically decide the amount of tax. This is clearly inviting corruption and bribery.

Abhishek . 6 years ago

Really discouraging for the Start ups…

Deepak Shahdadpuri . 6 years ago

One step forward but two steps back. In my view regressive and highlights the lack of understanding and impact of the VC and PE industry.

Manuraj Jain . 6 years ago

There is a workaround to this. HNIs take sweat equity at face value and pay for the company’s bills directly and expense it out in the income statement.

Manuraj

Vinculum Capital Partners

http://www.vinculum.in

Anon . 6 years ago

Few years bank, the secrerataries in North Block infact did not understand the PE / VC concept. Precisely how they proposed sectors like poultry farming as an exemption!

The example above of Kalaignar is a good one but taxing bribes in a funny excuse. Are they legalizing it?

They efforts to raise funds for infra came to a cropper due to their refusal to let private investors make good returns. So the PEs could not invest for few years as they could not promise good returns to the LPs from the endowment / pension funds.

The idiotic proposal above bares testimony to the fact that infact it is the VC/ PE industry which has failed to educate the government babus on the role played by them in the economy.

I do not know how many people have made presentations to the government on the importance of VCs and angel networks. Would it surprise you to know that the babus infact might not even clearly understand the entire concept of angel networks and their importance in the investment ecosystem inspite of efforts of this community to spread awareness.

It would help if some representation is spent in the right places rather than play ding dong with the media.

Just thank your stars this is not retrospective from the last century.

Sumeet Mitra . 6 years ago

This is sheer discouragement. In India, historically the biggest lending community ie. Banks only lend to entities that dont require the money! Angel investments have really helped dozens of start ups succeed and move ahead. Mr. Pranab Mukherjee, if you let start ups and entrepreneurs grow and succeed, you will create a wider tax net and collect MORE Tax over the longer term! This classroom economics has mysteriously evaded the politico think tanks! Instead they have chosen to penalize companies and entrepreneurs seeking to grow by bringing in this discouraging clause!

ram . 6 years ago

What or how can we mobilize to lobby against this well intentioned but idiotic rule which brings in license raj, corruption..It will have to happen through Indian Angel Network, Mumbai Angels etc..People like Nandan Nilekeni will have to be lobbied on this..

Vinod Keni . 6 years ago

A regressive step that has not been thought through. Will limit startups, innovation and job generation! Almost every country is promoting angel investments and startups. There were other ways of curbing money laundering and black money.

Ramanuj Mukherjee . 6 years ago

the intention of the government was to tax the income of companies that engage in license trading or favour trading (getting investment in return of political favour) – like the 2G scam companies. They have left out VC investments – but practical problem is that most so called VCs and angel investors do not register with SEBI as a VC fund – so to that extent its a tricky situation. now the angel investors will have to get a VC registration with SEBI if they want to avoid this tax.

The registration itself takes 6-8 weeks, application and registration fee of 6 lakhs have to be paid to SEBI, minimum firm commitment of raising 5 crores is necessary, the fund can be either in form of a company or a trust. there’s nothing preventing angel investors from taking this registration with SEBI on the face of it, except there’s some discretion on part of SEBI and the criteria for registration is not completely objective.

I am really looking forward to hearing what kind of experience VCs had trying to register with the SEBI so far. Anyone has any idea?

Ram Sharaph . 6 years ago

Genuine investments will suffer, whereas corrupt investments will find a way around this. The Government should certainly take a re-look.

Vijay Sambamurthi . 6 years ago

Adding to the numerous good points that have been made already by others, I think this proposed change goes far beyond merely making fundraising from angels unviable for start-ups!!! What about something as simple as further investments from promoters/existing shareholders, would that be covered too? It certainly seems so!

There are several perfectly legal and commercially sound reasons why a promoter may wish to infuse additional capital into a company and allocate a significant portion of that investment as a “share premium”. For example, under the Companies Act, funds lying in the securities premium account can be used for a host of purposes like funding buy-backs, issuance of bonus shares and so on, for which the funds lying in the “share capital” account cannot be used. By introducing a tax on any funds collected by companies above FMV (which, by the way, is proposed to be computed as the IT authorities will notify and deem fit), the Government is seeking to take away flexibility available under the Companies Act to Indian businesses to structure and use their capital in the most efficient manner.

Lastly, I do hope that the Government doesn’t really believe this move will address routing of bribes/criminal proceeds through share subscriptions at a premium. Odds are very high that with this measure, the baby will be thrown violently out while the dirty bathwater stays right in! If bribes are now indeed being routed thru share subscriptions at a high premium, then that practice will likely continue unabated, only, with a 33% tax leakage (going to the Government) and the rest being retained by the bribe-taker! And of course, all the while, honest and aspiring businesses will struggle to either raise seed capital or to structure their capital efficiently.

badri . 6 years ago

guys- this will need tax experts to comment. “person” in income tax act is not just an individual. this will apply to any entity other than a VC firm as excluded. so even a company investing in another company will be attracted by this provision. second, it seeks to look at investment values exceeding fmv. the fmv identification is always contentious. now in many cases where PEs invest, it is not possible legally to invest at values higher than declared fmvs as per RBI rules. so it seems to try and block some cases where inflated valuations are used to evade tax or the finance ministry has identified certain type of transactions that evade / avoid tax. i do not believe this clause will operationally cause any issues for angel investors. i am not a tax expert – any one in this group one to commment on these points ?

Kapil . 6 years ago

The lack of understanding of VC / PE functioning in the North block is a big surprise. How can a democracy allow such below – the – merit people sit in seats of policy making, which effects nation’s economy. To see the economic progress getting derailed by policy makers is of a major concern – I am sounding like a opposition member to myself, I do not like it, but a way has to be found around to amicably promote entrepreneurship

Crazy Idea: Budget 2012 Asks Startups To Pay Tax On Angel Investments

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