The Department of Industrial Policy and Promotion (DIPP) is soon going to notify an amendment to the angel tax for startups, which will provide much-needed relief for the firms, a report in a financial daily stated.
Startups incorporated before 2016 that have received up to Rs 10 crore in angel funding won't have to pay angel tax, an unnamed official with the DIPP told The Economic Times. The government department will also set up a separate committee to recognise such startups so that they get the tax relief, the person added.
However, the lack of clarity on what constitutes an angel investment still seems to be an issue with angel investors.
“[Only] an official government notification clarifying what constitutes an angel investment [will] settle things once and for all. Will they treat family and friends [that] help startups as angel investment?" asked an angel investor who did not wish to be identified.
The investor added that what constitutes a startup has been clearly enunciated by the DIPP and that should be done for angel investments as well. "Until then, startups will still have to reply to CBDT (Central Board of Direct Taxes) notices," the person added.
Finance Secretary Hasmukh Adhia on Monday stated that genuine cases of startup valuation as assessed by the DIPP will be exempt from paying taxes on angel investments received. This would also apply to firms founded before 2016.
Most angel investors VCCircle spoke with, however, maintained that if this happens, it will bring an end to angel tax issues. "The limit of Rs 10 crore is a reasonably high amount. Most startups’ angel investments in India are below that and will benefit [from the tax break]," said V Balakrishnan, founder and managing partner at Exfinity Ventures.
Under the existing rules, funds raised by an unlisted company through equity issuance are covered under this tax to the extent that the amount raised is in excess of the fair market value. Such extra inflow was taxable as “income from other sources” under Section 56(2) of the Income-Tax Act and charged the corporate tax rate, resulting in an effective tax of over 30%.
The angel tax was introduced in the 2012 union budget. The government's idea behind the tax was aimed at closing a loophole for money laundering by investors who invest and then take money out at a high premium.
"People try to game the system and why the government tried to introduce this. But angel funding is minuscule and is like killing early-stage startups that lay golden eggs. But it is moving forward and we will have more clarification in a couple of weeks," said angel investor Sunil Kalra.
The government tried to give concession to startups by stating that only those companies that fulfil the conditions specified by the DIPP as per a circular dated 17 February 2016 are eligible for the angel tax exemption. Since 2016, startups have been registering themselves with the DIPP and do not face CBDT scrutiny over angel investments. Most startups have successfully registered with the government agency.
The issue came to a boil last month when Nasscom, TiE Mumbai and Indian Angel Network issued a joint statement requesting the government to do away with the angel tax. They proposed that the government recognise and approve angel investor groups, and startups raising monies from these groups be exempted from Section 56.
Again in January this year, a few entrepreneurs started a petition on Change.Org demanding that angel tax be abolished as it ran against the spirit of the Startup India programme initiated by Prime Minister Narendra Modi.
The angel tax was also a big reason angel and seed investments in startups dropped last year. Apart from converting the disallowed capital investment into income, the tax levied further stresses the cash flow of the startups. This also results in the company raising more money at a low valuation.