The Finance Bill, 2023 has sought to include foreign and non-resident Indians under the ambit of the contentious angel tax provision applicable to early-stage startups. The fine print of the bill now requires non-resident Indians and foreign investors in private companies (including startups) to pay tax on any or all shares that are issued on premium pricing. This is expected to increase the tax burden on foreign angel and seed investors, according to investors and experts.
The move could dent startup investments in the country by foreign investors such as SoftBank, Tiger Global, Alpha Wave and Sequoia.
Section 56 of the income tax law includes a special provision which states that a privately held company issuing shares at a higher price than the audited fair market value is subject to a tax which is chargeable to the amount received in excess of fair market value.
The Section 56 provision of the IT Act had earlier caused uproar and much dismay among startups citing that this amounts to ‘over-taxation of angel funds’ raised by a startup.
However, startup founders who incorporated their business before April 2016 can apply for exemptions from this section. Apart from this, angel tax was also exempt for capital raised from Sebi-registered AIFs and for capital raised from overseas investors.
But under the new addition to the Finance Bill, 2023 foreign and non-resident angel investors have also been brought under the angel tax ambit.
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Mukesh Bhutani, partner, BMR Legal, termed it a “regressive” move. Siddarth Pai, founding partner at 3one4 Capital and co-chair, regulatory affairs committee at IVCA, said the angel tax provision (Section 56(2)(vii b) of the Income Tax Act, 1961) was an “anti-abuse measure” inserted in 2012 to prevent the laundering of black money via investments with a large premium into unlisted companies. Pai said the section was later misapplied to Indian startups 2016 onwards as their capital raises, which often happened at a premium above the face value of the securities, were taxed in their hands as income.
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“This taxation of a capital receipt as income was unique only to India. Given that the assessments happened years after the raise, many startups didn’t have the cash to pay the tax, nor could they raise capital as it would all go to clear out the angel tax liabilities,” he added.
Pai went on to add that the Budget 2023 inclusion of foreign investors under the ambit of angel tax “creates uncertainty and fear in the minds of Indian entrepreneurs”. He added that it may infuse far-reaching implications for the Indian startup ecosystem as a majority of the funds are raised from overseas investors whose investments will now be subject to angel tax.