What is Angel Tax?

Context:

The Finance Bill 2023 has proposed some changes that will remove the exemption for foreign funds and non-resident investors, who will now have to pay Angel Tax on the difference between capital raised and the fair value of securities sold.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

1. Angel Tax
2. Proposed Change to Angel Tax
3. Why are start-ups concerned?

Angel Tax

• Angel Tax is a 30% tax levied on funding received by startups from external investors.
• The tax is imposed when startups receive angel funding at a valuation higher than its ‘fair market value’.
• It was introduced in 2012 under section 56(2)(vii b) to fight money laundering.

Why is Angel Tax Problematic?

• There is no definitive way to measure the ‘fair market value’ of a startup.
• Investors pay a premium for the idea and business potential, but tax officials seem to assess the value based on the net asset value at one point.
• Startups find it difficult to justify the higher valuation to tax officials.

CBDT Notification on Angel Tax

• In May 2018, the Central Board of Direct Taxes (CBDT) issued a notification exempting angel investors from the Angel Tax clause subject to certain terms and conditions specified by the Department of Industrial Policy and Promotion (DIPP) now renamed as the Department for Promotion of Industry and Internal Trade..
  • Despite the exemption notification, startups still face a host of challenges to get the exemption.

Proposed Change to Angel Tax

• The Finance Bill, 2023 has proposed an amendment to Section 56(2) VII B of the Income Tax Act.
• The provision previously stated that an unlisted company (such as a startup) receiving equity investment from a resident that exceeds the face value of the shares, would be counted as income and subject to tax under “Income from other sources”.
• The proposed amendment extends this provision to include foreign investors, meaning that funding received by a startup from a foreign investor will now also be taxed as income.
• The tax applies if the fair market value of the start-up shares is higher than the amount offered to the investor.
  • For instance, if the fair market value of a start-up share is Rs 10 apiece, and in a subsequent funding round they offer it to an investor for Rs 20, then the difference of Rs 10 would be taxed as income.
• The angel tax was first introduced in 2012 with the intention to prevent the generation and use of unaccounted money through the subscription of shares in a closely held company.

Why are start-ups concerned?

• Funding Drop: According to a report by PwC India, funding for India’s start-ups dropped by 33% to $24 billion in 2022 compared to the previous year.
• Importance of Foreign Investors: Foreign investors are a crucial source of funding for start-ups and have helped increase their valuation. Notable investors like Tiger Global have invested in over a third of the start-ups that have achieved a unicorn status with a valuation of at least $1 billion.
• Impact on Non-Resident Investors: The proposed change includes foreign investors in the scope of the tax, which was previously not the case. This has raised concerns as it could impose additional tax liabilities on foreign investors for their investments in start-ups.
• Concerns about the Re-introduction: The re-introduction of the tax is seen as counter-intuitive to the efforts to attract startups back to India and could instead encourage start-ups to flip overseas.
• Lack of Clarity: There is confusion and concern among start-ups about the impact of the proposed change as they fear it could negatively affect the flow of funding from foreign investors.

-Source: Indian Express