By Mona Singh
Angel tax has long been in the news, affecting the Indian startup ecosystem. Announced as an effort to regulate startup growth in India, the initial announcement of the angel tax, on the other hand, rattled the ecosystem and made it difficult for early-stage companies to raise money in their early stages.
Understanding ‘Angel Tax’
Startups in India raising any capital for their business via selling shares to investors will be levied a 30.9% of tax. It will be imposed on net investments over the fair market value (FMV), putting a considerable financial burden on startups that are not yet profitable and do not have significant revenue streams in their earliest growth stages. On the contrary, it makes investors hesitant to invest in startups to avoid high tax rates that further reduce the flow of capital in the ecosystem.
This contretemps finance ministry with the Department for Promotion of Industry and Internal Trade (DPIIT) as well as other stakeholders over angel tax rules. Post the announcement, the union government proposes an ambit of new rules amended under Finance Act 2023 – Section 56 (2) (VIIIB) of the Income Tax Act, 1961 to create a positive regulatory environment for the ecosystem’s stakeholders.
Increase in Threshold
After the announcement, startups urged the finance ministry to eliminate or at least raise the threshold limit from Rs. 10 Crore to exempt startups from angel tax. Under the revision of new tax rules, the exemption limit has been raised to Rs. 25 Crore expanding the pool of startups to attract angel investments.
This facilitates startups to attract higher amounts of investments required to back their initial growth phases without having to worry about tax implications. Additionally, startups having incorporated for less than 10 years and not exceeding an annual turnover of Rs. 100 Crore in any previous year can also avail angel tax exemption and focus on nurturing their business growth with no tax implications.
Diverse valuation methodologies
As FMV plays a critical role in angel tax provisions, startups flagged several concerns over the valuation methodologies. While the previous rules only included book value or discounted cash flow evaluation startup methodology, the Central Board of Direct Taxes (CBDT) has expanded its valuation methodologies to create a credible investment scenario.
The addition of more valuation methods enhances flexibility for both resident and non-resident investors. As a result, this will enable sustained growth, opening avenues for global investors to pour funds into the Indian startup ecosystem. Furthermore, the rules specify a safe harbour of 10% variation in startup valuation can prove to be a considerate move in dynamic market conditions including forex fluctuations, bidding processes and economic indicators to deal with the unpredictability of unquoted equity share values.
Exemption for specified entities
To enable a favourable funding environment, CBDT has taken a step to exempt certain categories of investors and entities from angel tax. Non-resident investors including multilateral entities, foreign banks and insurance companies, foreign portfolio investors and entities registered with the Securities Exchange Board of India (SEBI) will not face angel tax implications.
Broad-based pooled investments – funds where the number of investors is above 50 and barring hedge funds are also exempted from tax purview. The step will break fresh ground for global investors to enter a regulated ecosystem and bring funding stability amid harsh winter.
The introduction of angel tax started with fear in stakeholders of the Indian startup ecosystem. However, certain exemptions stated in recent series of announcements proves to be a progressive step in creating a favourable startup ecosystem. Increased threshold limit, simplified compliance, exemption for foreign investors and variation in valuation will encourage entrepreneurship in a highly regulated environment.
(Mona Singh is the Co-Founder of India Accelerator.)
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