Understanding Angel Tax for Startups in India
Ever since the Modi government started with the plan of Startup India, we have seen an incredible surge of new companies coming up from different parts of the country.
In recent years, Indian companies have seen incredible investments. The investor community across the world has come up with serious investments in the Indian market because of the sheer size of the market that is up for grabs in the second most populous country in the world.
High net worth individuals, foreign funds, angel investors, venture capitalists, almost every possible individual or a company that is capable of investing has played a role in investing in various Indian startups.
However, while the Modi government promotes the development of startups in India, the government has continued to impose the angel tax on startups.
The tax was introduced in 2012, but the Modi government had promised to exempt companies from it. This finally happened in February 2019, when the Indian government made some amendments to the angel tax, giving a much-needed breather to startups.
Since the angel tax has been a hot topic in the industry of late, let us discuss a few things about this to get a better understanding of it.
What is an angel investment?
An angel investment is an investment made by an angel investor. An Angel investor, more often than not, invests only in startups or new companies that are yet to get great recognition. Such investors identify promising startups and invest heavily in them in return of ownership, equity or convertible debt.
What is angel tax?
Angel tax in India is a unique tax where a startup has to pay a certain percentage of the angel investment they receive to the Government of India, under specified conditions.
This startup tax states that the receiver of the investment needs to pay a certain tax if they get an investment higher than the Fair Market Value (FMV). The concept behind this is that the extra amount is seen as an income, and hence, the receiver has to pay taxes according to the income tax laws.
What is the problem with angel tax?
The fundamental problem with this tax is that it is imposed only if a resident investor makes the investment. This is not allowing Indians to invest freely and furthermore, startups are feeling the heat immensely.
Investments from non-resident investors and venture capitalist funds do not fall under the ambit of angel tax.
How much is the angel tax?
Angel tax is charged at the maximum marginal rate of 30%. This large percentage affects the investor as well as the receiver as they are losing almost one-third of the investment in taxes.
If you get an investment of â‚¹100 crore from an investor, but your company deserves an investment of only up to â‚¹50 crore according to the FMV then the remaining â‚¹50 crore is considered as an income. 30% of that â‚¹50 crore is â‚¹15 crore, which is a massive chunk of the initial investment.
Why are startups opposing it?
A few reasons why startups are opposing angel tax are:
- The process that companies use to calculate their market value differs a lot from the method the government uses to calculate the same. Many factors do not come into play when the government evaluates the market value of a company, resulting in a lower value. However, angel investors invest looking at the true potential of the startup and hence come up with huge investments. This clash in the process results in substantial price variations, which later leads to the payment of huge taxes
- Angel tax inevitably wipes away a significant chunk of the investment, which small companies get after a lot of rounds of funding. Moreover, it has affected the industry a lot, discouraging investors from investing big in smaller companies
- Angel tax invariably shunts the growth of the startup, leaving the young entrepreneurs dispirited
After facing a lot of backlash from the startup and investment community, the Indian Government has finally made some changes to the laws to make it a bit friendlier to investors and entrepreneurs.
What changes did the government make to angel tax?
The government has made the following changes:
- A company will be considered a startup for its first 10 years from the date of its registration. Earlier, this was set at seven years. This allows the startup to get an exemption from the income tax laws for three more years
- The entity will remain a startup if it does not experience a turnover of more than â‚¹100 crore in any of the financial years, which earlier was set at â‚¹25 crore. This allows startups to grow even more
- The income-tax department issued a notice of exempting startups from angel tax, provided they meet certain conditions
What are the conditions to get exempt from angel tax?
A few of the conditions that qualify a company for exemption from angel tax are:
- The paid-up capital and the share premium of the startup must not exceed the bracket of â‚¹10 crore, post issuing the shares
- The startup cannot estimate the market value on their own but seek the help of certified merchant bankers
- The investor should have a minimum net worth of â‚¹2 crore. Moreover, the investor’s income in each of the last three years should not be less than â‚¹50 lakh. If an individual meets these requirements, only then can he or she qualify as an angel investor.
What lies ahead for startups in India?
Even though this news comes as a relief to young entrepreneurs, the startup ecosystem still has a lot of issues, especially with the Article 68, which adds a huge tax liability for startups if they cannot disclose the source of funding.
The unexplained fund receipts push young entities into various financial troubles. Young entrepreneurs go through many pains to get funding, and the least the government can do is not add more hindrances to their growth by adding more taxes on their funds.