Angel Tax Relief to Startups!!! Is it Enough?

The DPIIT notification provides relief to Startups against Angel tax. But are these enough for the Indian Startup Ecosystem? Read and find out!

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The recent Angel Tax controversy was considered to have tainted the evolving startup ecosystem of India. The early-stage investments in startups were considered as ‘Income from other sources’, and were taxed at nearly 30%.

Read more on: What is Angel Tax? and its impact on Startups!

Tax notices were issued to a number of startups for funding received from angel investors. These tax concerns were believed to drain the funds of startups. For startups, funds are usually scarce, especially in their early stages.

The agitation and protest by the startup founders and angel investors urged to government to ease the norms for angel tax and facilitate the growing startup ecosystem in India. Read more on: What Startups and businesses want?

A notification was issued by the DPIIT(Department for Promotion of Industry and Internal Trade) on 19th Feb 2019, with a wider definition of a startup in India. The process for getting an exemption on investments u/s 56(2)(viib) of the income tax act, 1961 has been simplified.

Note: DPIIT was earlier known as DIPP(Department of Industry Policy and Promotion)

As per the revised rules, an entity is a ‘Start-up’ if:

• Up till 10 years, after the date of incorporation or registration.- This was earlier limited to 7 years
• The turnover limit has been increased to INR 100 crores for a financial year.- Earlier the exemption was allowed for a turnover limit of INR 25 Crore
• The funding received is not more than INR 25 crore.- The funding limit earlier was INR 10 crore

The investments received from the following entities will be excluded from the limit of INR 25 Crore

• Non-residents
• Category I AIF(Alternative Investment Funds)
• Listed companies having- Net worth of INR 100 crore, Or Minimum turnover of INR 250 crore

The startup to qualify for an exemption should be:

i) Privately held company

ii) Recognized by DPIIT

After fulfilling the above conditions, the second level of screening emphasises on the company not investing in:

• Building or Land appurtenant other than which is used by the startups for the purpose of renting, stock-in-trade, in the ordinary course of business
• land/building or both, not being a residential house;
• loans and advances, other than those extended in the ordinary course of business by the startups where the lending of money is a substantial part of its business;
• a capital contribution made to any other entity;
• shares and securities;
• a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds Rs 10 lakh, other than that held by the startups for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
• jewellery other than that held by the startups as stock-in-trade in the ordinary course of business;
• any other asset

Thank God! For the Relief

These recent changes were largely welcomed by the startup ecosystem. The founders and CEOs were granted relief from the changes by the DPIIT since the pressure on the cash-flows and funds is expected to reduce. This would allow startups to

• Utilise the funds in potential revenue generation streams.
• Raise more funds without then being taxed.
• Taking advantage of the startup status.

A typical angel funding rounds go up to $2–3 million which are nearly INR 14–21 crores, after which VC(Venture Capital) come into play. According to an article by VCCircle, if the limit was to increase, the VCs come into the picture and their investments would be made tax-free. This measure would be considered a harsh measure by the startup ecosystem.

Still, a Long Way to Go!

As welcomed these changes are, there is still a long way to go for supporting the startup ecosystem in India.

Some ideas require higher investment from angels since the business is not matured or developed to the stage for VCs to invest in. According to Vikas Srivastava, a partner at L&L Partners says-

“This limit may not entirely address the concern of scalability in a competitive market like India.”

He believes- the investment limit of INR 25 crore is not substantial for the current market. The value of an idea could be enormous which might not be backed by an equivalent amount of assets and cash-flow with the limit of INR 25 crore.

Many countries are offering startup visas, easy access to neighbouring markets(like EU) and most importantly tax-breaks, to attract startups for moving their headquarters. With angel tax worries in India, startups are finding locations abroad more attractive.

The startup ecosystem still struggles with obstacles of bureaucracy. To become eligible for tax exemption, the startups have to get permissions from DPIIT.

When startups receive funding, they invest or park the money in such instruments temporarily. One of the conditions for tax exemption is- The startup should not invest in shares or securities. S Vasudevan, a partner at Lakshmikumaran & Sridharan Attorneys, says

Securities’ is a broad term and would include investment instruments like mutual funds, which are commonly used by startups.

The conditions also restrict startups from making any financial contribution to another entity. If the startups’ want to benefit from the exemption, they cannot have any subsidiary or an associate firm. Many startups and firms having an international presence are required to have an associate or subsidiary in foreign geography. With Indian startups going global, such provisions would hold back Indian startups from going international.

The IVCA(Indian Venture Capital Association), said that the DPIIT notification does not address the section 68-which deals with ‘Unexplained Cash Credit’, nor does it provide relief to the startups currently struggling with tax payment orders. The Industry body also mentioned “Startups that have or will receive funds from Category II AIFs or other subcategories of Category I AIFs, are outside the purview of automatic exemption”

The angel tax norms were eased and are said to benefit more than 7000 startups out of nearly 16000 startups registered with the Government. However, nearly 250 startups which received orders for tax payment will not benefit from the change. They would still have to undertake the whole appeal process. The other 2000 startups which received tax notices can avail the shield under this scheme.

India in 2018 was the 3rd biggest startup hubs in the world, initiatives like startup India were launched to boost the startup ecosystem in India. However, to maintain and grow India’s startup position strong globally, radical actions must be taken. Dissolving angel tax norms would encourage the startups, instead of holding them back by diluting the Angel tax norms at a slow pace with restrictive conditions.

Being a startup ourselves, we at Quicko understand and support our fellow startups. You can register your startup and file taxes using Quicko with the help of our experts.