Startups are hoping that the Union Budget 2024, to be tabled in Parliament on Tuesday, will rationalise the provisions of angel tax. Rohinton Sidhwa explains what are the concerns regarding this tax and the reliefs that startups are seeking
l What is the angel tax?
SECTION 56(2)(viib) of the Income-tax Act, 1961 was introduced to target taxation of investment made in closely held companies in excess of fair market value (‘FMV’) of such companies. The excess consideration is chargeable to income-tax under the head ‘Income from other sources’ in the hands of the company issuing the shares.
Since investors in early-stage startups are often referred to angel investors, hence the name ‘angel tax’. Angel tax was first introduced in the Union Budget 2012 by then finance minister Pranab Mukherjee under the UPA-II regime.
l What is the rationale behind this levy?
CLOSELY HELD COMPANIES are subject to limited regulations in comparison to publicly traded companies. In order to increase the onus of proof on closely held companies, earlier being used as a vehicle for funneling unaccounted money, the government introduced an anti-abuse measure in the Union Budget 2012 in the form of angel taxation to tax any consideration received by closely held companies on issuance of shares in excess of its fair market value (‘FMV’).
l What have been the amendments to this rule since its introduction?
ANGEL TAXATION PROVISIONS were first introduced in the Union Budget 2012 only for investments made by resident investors. However, the Finance Act 2023 enhanced the scope to include investments made by non-residents also. Hence, the provision was made applicable for receipt of consideration from any person for issue of shares irrespective of their residency status. It also provided some relaxations to certain categories of investors.
l Concerns of the industry
IN AN ATTEMPT to circumvent generation and use of black money, genuine investments being made into a company were also brought into the tax net. One of the biggest requirements when starting a business is funds. Taking away around 30% by way of angel tax from investments made into companies starting or growing its business in India goes against the concept of ease of doing business in India.
l Measures taken by the government
AT THE TIME of introduction itself, investments by a venture capital fund or company in a venture capital undertaking were kept outside the ambit of angel tax. Subsequently, the government provided relaxation to certain startups as recognised by Department for Promotion of Industry and Internal Trade (DPIIT) and having share capital (inclusive of share premium) lower than Rs 25 crore, pursuant to new issue.
In 2023, the government provided further relaxations to investors including government and government related investors, banks, entities in insurance business and certain categories of investors based in 21 jurisdictions as notified by it.
Interestingly, a lot of prominent jurisdictions from where investments are made into India were left out. It also notified new valuation methodologies for determining the FMV of the shares to move towards a better and fair valuation in accordance with modern methodologies, rather than past driven net asset value or discounted cash flow or open market methodologies (as may be applicable for equity and preference shares).
As part of such notification, it introduced a safe harbour rule for price variation up to 10% from the FMV of shares on account of factors like forex fluctuation, bidding process, other economic indicators, etc., which may affect the FMV of shares.
l Expectations from the Budget
WHILE THE GOVERNMENT has introduced a few of the above initiatives to provide relaxation, it comes with conditions attached. The industry is particularly hopeful for the elimination of angel taxation provisions. Ahead of Budget 2024, the secretary of DPIIT has also recommended the removal of the contentious angel taxation provision for startups, which would finally aid in capital formation in the country.
At the very least, the government should consider rationalising the provisions by providing clarifications on non-applicability of the provisions of angel taxation on issuance of shares in tax-neutral transactions such as amalgamation and de-merger, exemption on rights issue and upon conversion of convertible instruments.
The writer is partner, Deloitte India