scorecardresearch

Angel tax on NRI investors may worsen funding winter

While the Finance Bill passed by Lok Sabha on Friday did not provide any relaxation to investors despite requests from the startup ecosystem, a note shared by the ministry of finance said concerns raised by stakeholders would be addressed.

tax
The angel tax provision was first enacted in 2012,

Indian startups failed to receive any relaxations from the proposed changes to the angel tax provision, which seeks to include foreign and non-resident Indians under the tax regime.

While the Finance Bill passed by Lok Sabha on Friday did not provide any relaxation to investors despite requests from the startup ecosystem, a note shared by the ministry of finance said concerns raised by stakeholders would be addressed. “The draft rules related to valuation shall be shared with the stakeholders for their inputs in the next month itself, viz April,” the note added.

Venture capital investors and taxation experts that FE spoke with indicate that the ongoing funding winter, which has led to several startups rationalising costs and cutting jobs, may be further aggravated if the government doesn’t provide additional relaxations.

“The majority of the funding into Indian startups comes from foreign sources. If the government doesn’t issue exemptions to international institutional investors soon, the current funding winter will get further exacerbated. NRIs and non-institutional international investors may face headwinds in terms of their investments into Indian startups, exposing such startups to angel tax,” Siddarth Pai, founding partner, 3one4 Capital, & co-chair, Regulatory Affairs Committee, IVCA, said.

Experts also fear that the ongoing banking crisis in the US markets coupled with fears of recession may dampen Indian startups’ ability to attract crucial funding from foreign-domiciled investors.

“With the recent collapse of global banking giants (SVB, Credit Suisse, etc.), there may have been certain deals which are now expecting funds as investments later than sooner. Therefore, it seems that the expected funds to be coming will now have to meet the newly implemented valuation guidelines,” said Saurrav Sood, practice leader – international tax & transfer pricing at SW India.

The new provision which brings NRIs under the ambit of the angel tax regime was introduced in this year’s Budget under the Finance Bill, 2023. 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, experts said.

The move could dent startup investments in the country by foreign investors such as SoftBank, Tiger Global, Alpha Wave, Sequoia and other international VCs and early-stage investors.

Section 56 of the Income-tax Act 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.

“There was confusion about whether this goes live from April 1, 2024, or April 1, 2023. But the memorandum to the Finance Bill, 2023, clearly states that it applies from assessment year 2024-25, which is financial year 2023-24. April 1, 2024, in the Finance Act refers to the assessment year, not the financial year,” Pai of 3one4 Capital added.

Ankit Jain, partner, Ved Jain & Associates, said the angel tax tax provision was initially introduced in the Income-tax Act, 1961, by the Finance Act, 2012, to curb money laundering through unlisted companies. Under this provision, if a startup receives funding from an angel investor at a price that is higher than its fair market value, the excess amount is treated as income for the startup and is subject to tax at the rate of 30%.

When the angel tax provision was first enacted in 2012, it had caused uproar and dismay among startups, which said this amounted to ‘over-taxation of angel funds’.

Jain said the tax provision had often led to genuine startups receiving notices from the tax department for raising funds at a premium.

“The valuation of a startup is a complex process that involves factors such as the stage of the startup, its growth potential, the market size, the competition, and the team’s expertise. Startups are often valued based on their future potential rather than their current financials, which makes the valuation process subjective and prone to differences in opinion. A strait-jacketed approach will be detrimental to the growth of the startup ecosystem,”Jain added.

However, startup founders who incorporated their business before April 2016 can apply for exemptions from this section. Apart from this, capital raised from Sebi-registered AIFs and from overseas investors is also exempt from angel tax.

Pallav Pradyumn Narang, partner at CNK, said that currently, the angel tax provisions do not apply to startups that receive money from a notified venture capital undertaking (ie, a startup) through a venture capital company or fund.

“However, only a few startups are notified by the DPIIT, which means that the majority of unregistered startups raising funds from non-residents, especially non-resident angel investors, parent or holding companies, and friends and family, will be affected by this amendment. This could expose start-ups to tax on any money received that exceeds the fair market value,” added Narang.

Get live Share Market updates and latest India News and business news on Financial Express. Download Financial Express App for latest business news.

First published on: 25-03-2023 at 01:30 IST