The growth potential promised by the Indian start-up system has attracted foreign funds, VCs, Angels, and HNIs from all over the world. Government initiatives like Start-up India, Digital India, etc. have given a boost to Indian start-ups, making it easier for smaller businesses to enter the booming start-up ecosystem as well.
Angel Tax is one term that the start-up Industry is most skeptical about. The tax was introduced in the year 2012, but the Government had promised to exempt start-ups from it. In 2019, the government did not completely scrape the tax but made certain amendments giving some breathing space to start-ups.
What is Angel Tax?
By definition, Angel Tax is the income tax payable on the capital raised by unlisted companies through the issue of shares in off-market transactions. It is known as Section 56 (2) (viib) of the Income Tax Act and taxes start-ups for their funds raised if it exceeds the fair market value of the company. Simply, it is just the income tax a start-up has to pay on an investment (income). Angel tax is levied on capital raised through an Indian investor because it is seen more than the fair market value of the company. The excess realization of the investment, from the fair market value, is considered an ‘income from other sources’ for the business, therefore taxable. Currently, Angel Tax is levied at a hefty rate of 30.9%.
The start-up needs to get their fair market value certified by a merchant banker. The investor who is providing the investment should have a net worth of at least Rs. 2 crores and an average income of at least Rs. 50 Lakhs in the previous 3 financial years.
What kind of investment falls under the umbrella of Investment tax?
Angel Tax is imposed only on resident investors’ investments. It is not applicable if the investment is made by venture capital funds or non-residents. After much disagreement and protests from the start-up community, the current government had promised to make amendments. As of August 2020, a company will be considered a start-up for 10 years from the date of its registration (earlier this was less than 7 years). This allows a company to get an exemption from the tax for 3 more years.
A business will remain a start-up if it doesn’t earn a turnover of more than 100 crores in any of the financial years. This was set at 25 crores before 2019. Now, start-ups have more scope for financial growth without having to pay the tax. If a business is formed by splitting up or reconstruction of an existing business, it shall not be considered a start-up. (https://www.startupindia.gov.in/content/dam/invest-india/Templates/public/198117.pdf)
In the recent amendment, the government has simplified the compliance procedure by removing the mandatory fair market value certificate issued by a merchant banker and other approvals. Start-ups can simply request Angel Tax Exemption from the DIPP, Department of Industrial Policy and Promotion, with applicable supporting documents. This application is then forwarded to the CBDT, Central Board of Direct Taxes which accepts or declines the application within 45 days from the day of receipt.