“India will soon become the next start-up hub like Silicon Valley”, Ashima was excited to discuss the plethora of opportunities in the Indian start-up ecosystem with Anuj.
“I don’t think so. The start-up ecosystem in India is way behind that of Silicon Valley due to stringent legal and statutory compliances”, Anuj placed his disagreement firmly.
“How can you say this?”, Ashima was surprised and eager to know the reason behind Anuj’s disagreement.
“In the past few months, several start-ups have received tax demands to pay off taxes on angel funds raised by them. Angel funds are raised in the early stages of the business to speed up growth. How can start-ups grow big then?”, Anuj replied.
Anuj was right. Angel Tax is back to haunt the start-ups and angel investors alike!
Start-up India scheme was launched as an initiative to develop a sound ecosystem for new businesses and entrepreneurs by simplifying the existing rules, provisions and compliances.
While the government has come a long way in making this scheme a reality and has provided the impetus to start-ups, the Income Tax Department on the other hand has played spoilsport in more than one occasion.
Start-ups are now receiving tax notices and are asked to pay 30% tax on any investment raised over the fair value from angel investors.
Meaning of Angel Tax
According to section 56 of Income Tax Act, start-ups (unlisted) receiving equity share capital (angel fund amount) in excess of fair value must pay 30% tax on the excess amount. This amount is taxed under “income from other sources” for the start-ups.
Thus, Angel Tax = 30% of [investment amount – fair value of investment]
Angel tax was implemented by the Government initially to curb money laundering. It ensured that the companies receiving large sums from relatives, friends and angel investors can justify the same to the Income Tax Department and other authorities.
Difficult to calculate the fair value of a start-up
Start-ups and angel investors are stirred with anger over the angel tax issue because the point of taxation depends on the calculation of fair value and analysis of the excess angel funding amount received by start-ups.
Since start-ups operate in an uncertain environment and the fair value practically boils down to the negotiation between the business owners and angel investors, it is at times difficult to calculate fair value and justify the same to the taxmen.
Income Tax Dept sidesteps Government’s notification
Earlier this year, the government, through Department of Industrial Policy and Promotion (DIPP) had issued a notification exempting eligible start-ups from paying income tax on share premium amount received by them.
To avail the exemption, the total amount of angel fund investment should be less than INR 10 crores. Also, start-ups are required to submit valuation report obtained from a merchant banker specifying fair market value (FMV) of shares.
Further, the angel investor should have an average returned income of INR 25 lakhs or more for the preceding three financial years, or, a net worth of at least INR 2 crores on the last date of the preceding financial year.
Start-ups must apply and receive approval from the Inter-Ministerial Board set up by DIPP for getting exemption from paying income tax on the premium amount.
DIPP passes on the answerability to Department of Revenue
Several start-ups have approached DIPP after receiving angel tax notices. DIPP has raised this issue with Department of Revenue for clarity on the matter while start-ups are waiting for some positive news.
What is your take on this issue? Are you expecting the government to provide any relief to start-ups and angel investors on this issue?
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