Budget 2012 is not good news for entrepreneurs

Now that the Budget fineprint is emerging, the Devil truly appears to be in the detail. For the entrepreneurship and startups space, despite some sops given by Finance Minister Pranab Mukherjee to micro, small and medium enterprises (MSMEs), there is one clause which may derail the entire entrepreneurship movement currently taking place across the country.

There is a Budget proposal to tax at 30 percent any investment received by closely held companies where the aggregate investment exceeds the fair market value of shares. Put simply, this would mean an angel investor investing in a company where the investment is in excess of the fair value of the shares, will be taxed and his investment will be considered as income for the entrepreneur.

In Budget lingo, this pertains to cases “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 that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause 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”.[caption id=“attachment_248365” align=“alignleft” width=“380” caption=“Decoding his Budget. Image courtesy PIB”]  [/caption]

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While venture capitalists are not included, the entire angel investor space is a hugely worried lot owing to this proposal. In a report in The Hindu Business Line newspaper on 18 March, Quattro’s Raman Roy, a leading angel investor himself, was quoted as saying the proposal will ‘kill entrepreneurship’.

Saurabh Srivastava, a celebrated angel investor and co-founder of the Indian Angel Network, is also quoted in the report as saying the proposal seeks to tax the company and convert an investment into income.

Ravi Kiran, co-founder of middle-India advisory Friends of Ambition (FoA) and member of Indian Angel Network told Firstpost: “There seems to certainly have been an error in understanding on the part of the Budget makers. If this is pushed through, it will spell serious trouble for the angel investor and entrepreneurship space. I feel this is an error and should be corrected quickly before it leads to confusion.”

According to Kiran, who focuses on middle-India enterprises where there is a surge in entrepreneurship and interesting ideas, while the proposal seeks to treat angel funding as income for the entrepreneur, it also overlooks critical aspects of the whole angel funding model. “It’s not just the money an angel investor gives. Along with the money, he also does a lot of mentoring for the enterprises. Would you tax that? Angel investors commit money and several hours of guiding the entrepreneurs.”

Importantly, the clause also says “the fair market value of the shares shall be the value-(i) as may be determined in accordance with such 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, on the date of issue of shares, of its assets, including intangible assetsbeing goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.”

Angel investor circles also say that if the proposal is allowed to go through, it will also mean enough scope for negotiation with the assessing officer, and could lead to further corruption. “Investee startups will now start requesting Rs 120-130 for Rs 100 investments because the assessee officers will have to be taken care of,” points out an angel investor.

While Mukherjee, in his Budget speech referred to this move as one aimed at deterring the use of unaccounted money and “increasing the onus of proof on closely held companies for funds received from shareholders as well as taxing share premium in excess of fair market value” angel investors point out another growing phenomenon.

“Unlike, say, five to seven years ago, today a number of professionals and salaried people are coming into the angel funding space. Where is the question of unaccounted money in their case? The money they put in is already in hand after tax and when it is pulled out later, it will be subject to capital gains tax. Besides, angels don’t look at exiting in the short term anyway,” points out Kiran, emphasising that he feels it is a genuine error and would be corrected soon enough.

However, till the government clears the confusion on this, the startups and angel investor space is a hugely worried lot. As would be the hundreds of students from the IITs and IIMs who have decided to take up entrepreneurship-and not salaried jobs-as career options. Will Pranab Mukherjee do something for them?

(The writer is Editor-in-Chief of Entrepreneur magazine)