In this world, nothing is certain but death and taxes, so said Benjamin Franklin.
Overzealous governments aren't content taxing humans, they want to tax even Angels.
On a serious note, however, let's discuss Angel Tax.
Introduction
In the recently proposed Annual Budget for financial year 2024-25, the Union Government has announced the abolition of the Angel Tax. Levying of this tax primarily targeted startups and other unlisted companies receiving investments from angel investors. According to Finance Minister Nirmala Sitharaman, the main goal of this move is to strengthen the startup ecosystem and promote entrepreneurship. This article explores why the Angel Tax was introduced initially, its inherent flaws, and the reasons for its eventual abolition.
What is Angel Tax?
The Angel Tax was introduced by the UPA Government in Finance the budget for financial year 2012-13 and is covered under Section 56(2)(viib) of the Income Tax Act, 1961. Startups, in their early stages, often lack the reputation or significant assets needed to secure funds from banks or other regulated institutions. Angel investors provide crucial support to these startups, becoming a vital source of sustenance and growth for them in the initial phase.
According to the Finance Act of 2012, startups were required to pay tax on the investments they raised from angel investors if the amount exceeded the fair market value (FMV) of the securities. For example, if a startup raised Rs 10 crores from angel investors and the FMV of the shares was Rs 8 crores, the excess Rs 2 crores would be taxable as 'Income from Other Sources.' Thus, this tax was to be applied only when the investment amount exceeded the FMV of the securities issued. The provision became applicable from 1st April, 2013.
Rate of Tax
The Angel Tax was charged at 30.9% on the investment amount exceeding the FMV of the shares issued.
Underlying Objectives
The primary purpose of the Angel Tax was to prevent money laundering. In the early 2010s, there was a rise in money laundering cases, with many shell companies being established to transfer illegal funds. These companies often posed as startups and enjoyed tax exemptions in their initial years. The Angel Tax aimed to regulate startups and serve as an effective mechanism to curb these activities.
Another objective was to ensure that startups maintained proper financial records, as many cases of book manipulation were being observed. These manipulations led to significant amounts of black money in the economy. The tax was intended to provide oversight and ensure financial transparency among startups.
Drawbacks
The Angel Tax had several significant drawbacks. The high taxation rate of 30.9% discouraged startups from raising foreign investments, as a substantial portion of the funds would go to the government. Despite its objective to prevent financial manipulations, the tax led to an increase in such activities and the proliferation of shell companies.
Additionally, the tax hindered the growth of the startup ecosystem in the country, as the high tax rate deterred greater investments. There was also conflict regarding the jurisdiction of income tax officers in determining the FMV of companies. The FMV should be determined by the company itself, without interference from income tax officers.
These prominent drawbacks led to widespread criticism of the Angel Tax during its operation. The tax was perceived to be overreaching, unjustifiable and draconian in nature.
Exemptions Offered
To address the issues caused by the Angel Tax, the central government provided certain exemptions in the Union Budget 2019. Startups registered under the Department for Promotion of Industry and Internal Trade (DPIIT) were exempted from paying this tax, provided they met certain criteria:
- The startup's maximum paid-up capital and share premium after issuing shares should not exceed Rs 25 crores.
- A merchant banker must evaluate the FMV of the startup.
- The startup's annual turnover should not exceed Rs 100 crores in any of the past few years before raising share capital from angel investors.
According to the Income Tax Notification 2019, angel investors were allowed a 100% exemption on investing in startups with higher FMV, provided the average income of the angel investors did not exceed Rs 25 lakhs and their net worth did not exceed Rs 2 crores in the past three fiscal years.
Impact on Pending Litigations
In October last year, Inc42 reported that between February 19, 2019, and September 26, 2023, 10,809 DPIIT-recognised startups applied for the angel tax exemption. Out of these, only 8,066 received the exemption. In contrast, by June 21, 2019, just 944 startups had applied for the angel tax exemption, with 702 of them being granted exemption by the CBDT. This indicates that a significant number of cases are still pending under the angel tax provision.
All those Startups that raised capital at a premium in the current Fiscal Year, i.e., after 1st April 2024, shall not be required to file Angel Tax. However, those Startups that raised capital in previous years can still be sent notices for the same. This is a looming concern, considering that there are quite a number of litigations pending.
However, in such circumstances, the Government shall aim to come to the rescue. They can firstly withdraw the case after completing the verification that the investment is genuine. Secondly, they can adopt a remedial path under which the administrative notices issued to the Startups can be made less stringent. Further, the valuation of Startups should not be questioned and their reports must be respected.
Conclusion
The abolition of the Angel Tax in the Annual Budget 2024-25 marks a significant step towards fostering a more favorable environment for startups, as the Government aims to create an ecosystem facilitating 'Ease of Doing Business' in India. Initially imposed in 2012 to prevent money laundering and ensure proper financial records, the tax proved detrimental by hindering investment opportunities and growth within the startup ecosystem. Despite exemptions introduced in 2019, the tax continued to face criticism for its high rate and complex regulations. Its removal is expected to resolve pending litigations and provide relief to startups, encouraging greater entrepreneurial activity and investment in India's startup sector. This will contribute to a balanced approach between compliance and growth, ultimately leading to economic expansion.
References
1) Palak Agarwal, Angel tax abolished to boost India's startup ecosystem and innovation; experts hail decision, Available at:
2) Ministry of Finance, Press Release, Available at:
https://pib.gov.in/PressReleaseIframePage.aspx?PRID=2035599
3) Budget 2024: Centre abolishes angel tax in a major boost for startup ecosystem
4) Union Budget 2024: Nirmala Sitharaman scraps Angel Tax on foreign investments amid startup funding winter, Available at:
5) Angel Tax and the (UN)Ease of Doing Business in India, Available at:
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Parth Verma is a 4th year student of BBA LLB (Hons) at Christ, Bengaluru
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.