Angel Tax Insights for Start-ups

Angel tax is levied upon angel investors and the start-ups where the consideration for the investment made is over and above the “fair market value”.

Where India witnessed tremendous growth in the number of start-ups in the last few years. Various measures that were issued by the government of India are now one of the reasons that brought India's thriving business and start-up environment to a standstill.

Angel Tax is considered a counter philosophy for the start-up culture that India has been focussing on. The initiatives such as Start-up India lie in peril due to the angel tax introduced in the year 2012 by Pranab Mukherjee for controlling the money laundering issue.

Where India should be setting up a favourable tax environment, angel tax has made it impossible for start-ups to earn from their own business ventures.

One of the main issues for any start-up is raising fund in its initial stages and setting up an environment that gives them an opportunity to grow in the current environment. Angel tax is considered to be a deterrent factor for all the investors and is considered one of the major reason for the low angel investment in the start-ups.

Main factors that contribute toward a favourable environment for Angel Investment are:

India has shot into fame in the global investing ecosystem. Emerging in the start-up space in the 2000s, the country has achieved a lot with 13 unicorns successfully flourishing; India is now on the third-ranking in the global race.

 India is poised to be one of the largest markets that are facilitating start-ups to scale easily, leaving the US and China aside. The following are the key factors that facilitate Start-up growth in India:

  • Start-up India Initiatives
  • MSME or Small Companies Registration

What is Angel tax?

Angel tax refers to a term that is used for income tax that is payable by unlisted companies. The capital generated by such companies on the issue of shares and where the share price is in excess of the market value of the shares sold.

The excess in such case is considered or treated as income of the company, and hence the company is taxed accordingly.

Brought into Practice

The practice of charging the excess as income was started with its introduction in union budget 2012 union budget. The practice was brought to bring a stop to laundering activities.

The term came to be known as the Angel Tax since it affects the angel investments at large for start-ups. The Indian government charges 30% as angel tax if any privately held company raises investment that is more than the fair valuation.

What do Section 56(2)(vii)States

Section 56 (2) if the income tax act was inserted in the year 2013 after the financial budget of the year 2012 states that any company in which the general public is not interested in investing, if attains investment that exceeds the fair value will have to pay a tax of 30% of the excess value that is generated by them.

The assessing officer will determine the value of the assets that would include both tangible and intangible assets of the company, i.e. Intellectual Property of the company.

DPIIT Notification

A month before the Department of Promotion of Industry and Internal Trade (DPIIT) notified startups in India about exemption from the Income Tax Act section 56(2)(viib)  that deals with the Angel Tax the devil dancing on the startups head.

As per the report issued by economics, times stated that companies that received notification from Central Board of Direct Tax (CBIDT) had to submit form 2 with the government to exempt them from submission of the Angel Tax with the government.

The acknowledgment companies received in return of such mail just provided that the form has been received by the government of India and no other notification regarding exemption was as such provided.

Exemptions Provided

On February 19, 2019, the government of India had broadened the concept of Startups in India that provided an exemption to the companies incorporated as Startups from paying Angel Tax provided it completes following conditions

  • The company shall not have a turnover that exceeds Rs 100 crore for any fiscal year which was earlier set as Rs 25 crore.

  • Investment limit has also been increased from 10 crores to Rs 25 crore for tax exemption.

The following exemptions have been raised due to start-up India Initiative which has been amended recently.

The CBDT has also provided an exemption to 90 startups that had received notification from the tax authority to pay the required tax to the government within a stipulated period of time. They also get future immunity from angel tax on capital that would be raised through promoters of the company.

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