Demons of Angel Tax
By Himanshu Goyal, Manager at Asha Impact
India is one of the biggest hub for Startups in the world in terms of number of businesses. While the current government has stated the aim of promoting entrepreneurship in the country, the startup sector is now struggling with tax scrutiny.
The Angle Tax that has been levied on angel investment in startups is the reason behind such tax scrutiny notices.
What is Angel Tax?
Angel tax is a term used to refer to the income tax payable on capital raised by unlisted companies via issue of shares where the share price is in excess of the fair market value of that share. The excess realisation is treated as income and taxed accordingly. The Finance Act, 2012 added a new sub-section (viib) in section 56(2) of the Income-tax Act, 1961 to arrest laundering of funds. It has come to be called angel tax since it largely impacts angel investments in startups.
How does it affect Startups?
With the introduction and applicability of Sec.56(2)(viib), many start-ups started receiving income tax notices, whereby the authorities wanted to verify the accuracy of capital infused into the startup. Start-ups usually have their main source of funding from the introduction of share capital. Essentially, the capital introduced in these startups demand a huge premium, which used to be on account of the ideas, innovation or prospects, and the proposed execution by these entities.
Calculating the Fair Market Value of these shares by the procedures defined under Income Tax Act resulted into a blind application of Sec 56(2)(viib) on majority of startups. However, this practice could adversely impact the country’s startup culture, which the Government is keen to promote and incentivize.
What are the outcomes and present situation?
On the hue and cry made by the startups, the Finance Ministry clarified that no action would be taken against startups, which have been recognized by the DPIIT (Department for Promotion of Industry and Internal Trade).
To claim exemption under Sec.56(2)(viib), an entity has to fit into the definition of Startup and should have DPIIT approval. Accordingly, meaning of startups for the purpose of Sec.56(2)(viib) has been widened to cover larger entities and to build a strong ecosystem for nurturing innovation and entrepreneurship in the country.
For being a startup, an entity has to be either a Private Limited Company or a partnership firm or an LLP; should have been in existence for less than 10 years; should have never crossed a turnover of Rs. 100 Cr; and should be working towards innovation, development and similar fields with a high potential of employment generation or wealth creation.
Concluding remarks:
While the new regulations have been brought in with a good response, however, since the regulatory framework suffers from certain lapses (such as presence of subjectivity on the part of Assessing Officer), the new system of exemptions from the application of Section 56(2)(viib) can very well become a reel benefit instead of providing some real benefits to the startups. One of the ways for improving these lapses can be to introduce objective parameters basis which the system can decide whether a particular entity is eligible for the exemption or not. In this way, the very intent of the sec.56(2)(viib) can be achieved, by not just blindly applying the section, but actually benefiting the startups.
