Ghost of angel tax laid to rest: Is it a boon or a bane? The devil is in the details, say experts

  • Angel Tax was introduced by the earlier UPA govt in a bid to stem money laundering

  • Many felt that the government's withdrawal of the angel tax and setting up of a cell to address tax grievances of the startup sector indicates its serious intent

  • Angel tax is a tax on capital that is raised by unlisted companies by issuing shares in excess of their fair market value.

The ghost of angel tax has been laid down by the finance minister's announcement of rollback of angel tax amongst a slew of measures announced on Friday to provide a stirrup to the economy. Currently, there are over 24,000 DPIIT-recognised startups.

Angel Tax has been the bane for the fledgeling startups—entrepreneurial risks taken by those willing to start a firm or product innovation, etc. To risk everything they have made and embark on a new journey is filled with a lot of risks. Angel tax was the thorn in the journey for many who have been talking about it for long. Angel tax is a tax on capital that is raised by unlisted companies by issuing shares in excess of their fair market value.

Angel Tax was introduced by the earlier UPA govt in a bid to stem money laundering. Section 56(2)(viib) of the Income Tax Act, 1961, brings to tax any money received by a company from a resident on the issue of its shares to the extent it exceeds the fair market value (FMV) of the shares so issued. The government's bid to crackdown on suspected black money flow into the country's startup ecosystem gave a jolt to the sector.

 Ghost of angel tax laid to rest: Is it a boon or a bane? The devil is in the details, say experts

Representational image. Reuters

Section 56 (2) (vii) (b) of the I-T Act states: “Any consideration received by a company (startup) from a resident, against issue of shares, exceeds the fair market value of such shares, such excess consideration is taxable in the hands of the startup, as an income.” Any such extra inflow is 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 percent.

A startup is basically an idea which has some ability to be marketed. The startup founder/s then raise money from themselves and friends to get the idea ground up. After that, it usually goes to angel investors who help them develop the idea, may say if it needs to be tweaked or not, give them inputs on what markets to target, etc. Angels put in money into the project and also handhold the startup. After it gets traction and needs more funds, is when the Venture Capitalist steps in.

Last Friday's announcement from the Finance Minister has given much joy to the sector. It is a good start to boost the sector, said angel investors and lawyers dealing in startups.Angel Tax was one of the primary reasons behind the struggle new startups faced when raising capital, said Anil Nagar, Founder and CEO, Add247, an ed-tech platform which helps student prepare for all government exams. Nagar is confident that its removal will incentivise HNIs to take up the role of investors and mentors to emerging startups in the country.

Siddharth Rao, Founder & CEO of Dentsu Webchutney and an active angel investor in India's startup ecosystem, said from the previous position of being a draconian rule, Sitharaman's announcement is a relief. As an angel investor, he said, he was aware and took the risk with the startup sector by investing in companies. "When a rule such as an angel tax is issued, one realises that bureaucrats who were part of the decision-making had no clue about entrepreneurship. From starting up to raising capital to innovation, it is not a fun journey for an entrepreneur. To worsen the entrepreneurial's journey and add to his pain, terrorising them with angel tax was horrendous. Even shutting down a startup is littered with difficulties. The angel tax made many angel investors bitter about their investments and many stayed away," he said.

"As a law firm working with startups and investors, we found the question that was uppermost in the minds of startup founders and investors regarding a deal was about angel tax", said Roma Priya a Delhi-based lawyer, and founder of Burgeon. A certification is needed to state valuation. That has to be done by a merchant banker who charges around Rs 75,000 to Rs 1 lakh for it.

A two-year-old startup in the process of building it up goes to a merchant banker to get an inflated valuation. Valuation indicates the worth of the idea, the product or service and so on. Valuation is important to get funds. Besides, the credentials of the founder/s, the team, the demand of the product/service also plays a role in the valuation. Since the startup is an early work in progress, the valuation is an estimation--a future forecast. Too low valuation means there will be difficulty in getting funds; too high also could get keep away the right investors. The inflated valuation can lead to scrutiny from the Income Tax Department.

This announcement from the government, however, will promote startups which had angel investors fighting shy of investing due to the Angel Tax issue, among other issues. It also means more domestic capital will be available, said Priya.

According to the startup data platform, Traxn, tech startups raised around $10.5 billion last year, 5 percent lower than the $11.2 billion raised in 2017. The number of funding rounds also fell to 924 in 2018 from 1,161 a year ago. The number of angel and seed funding deals halved to 435 in 2017 from 901 in 2016, according to report. The total disclosed value of these deals also fell sharply to $245 million from $374 million in 2017.

Padmaja Ruparel, IAN, said besides withdrawing Angel Tax, the finance minister also spoke about setting up of a dedicated cell under Central Board for Direct Taxes (CBDT) with the view to addressing the challenges that start-ups and investors are currently facing. "It’s a good idea and I am optimistic that it will empower the Indian start-up ecosystem by pruning the lingering problems with the angel tax."

Many felt that the government's withdrawal of the angel tax and setting up of a cell to address tax grievances of the startup sector indicates that the government is keen and serious about the travails of the entrepreneurs. But Paula Mariwala, Partner, Seedfund and Co-Founder, Stanford Angels. She says that startups have to still abide by the February 2019 circular which rules that all start-ups would be exempt from Angel Tax if they do no make any investment -- in the land, building, vehicles, jewellery, etc for seven years from the date of issuing shares at a premium. Why does that still stand, she asks.

Even loans and advances given by startups disqualifies it for angel tax exemptions. "Its time the government paid attention to these details as well for it makes the startup journey challenging for entrepreneurs and entrepreneurship", says Mariwala. "The government must provide solutions for these bottlenecks as each startup contributes not just to making of innovative products or services but also is an important factor providing jobs," she said. The abysmal job sector, with job cuts and lack of jobs, could do with a leg-up from startups.

Updated Date: Aug 26, 2019 20:20:48 IST