Angel tax: Startups find much-awaited relaxation in norms by govt to be half-hearted

In order to claim exemption as per the relaxed rules, startups and investors will be required to make an application via DIPP in a prescribed format along with the essential documents.

income tax, income tax return
the cabinet sanctioned Rs 1,482 crore up to 2018-19 for the existing IT project of the department.
income tax, income tax return
The biggest clamour now is around the mandatory income tax returns requirement for an angel investor.

The aggrieved startup ecosystem over angel tax has finally been resuscitated. The latest notifications from the Department of Industrial Policy and Promotion (DIPP) to solve the issues around the ‘anti-abuse’ provision in the Income Tax Act in 2012 aka angel tax has been welcomed by the startup and investor community, to an extent. The voices of dissent among startups and investors still echo the ecosystem.

FE Online talks to multiple startups and investors to understand what would work for them now and what still might not.

Unwarranted Exemption

The biggest clamour now is around the mandatory income tax returns requirement for an angel investor of at least Rs 50 lakh for the year preceding the investment year. While the measure seeks to ensure the credibility of the angel investors and incorporate appropriate checks and balances, the definition of investor, according to serial entrepreneur and partner at venture-builder platform GrowthStory K Ganesh, to be eligible of tax exemption is unwarranted. This is because most of the times the initial money comes from friends and family in small amounts.

“For instance, if an entrepreneur raises Rs 5 lakhs from his relative, the amount will be taxed unless the relatives had the income of Rs 50 lakhs per annum or net worth of Rs 2 crores,” said Ganesh.

“Family and friends should be exempted from the angel definition as they are the first source of funding for startups in many cases,” said Anil Joshi, founder and managing partner, Unicorn India Ventures.

Limiting Scale

Further, revised guidelines state that a startup’s combined amount of paid-up capital and share premium after the issuance of shares should not go beyond Rs 10 crores for angel tax exemption. This, says startups, seems arbitrary and punishes those startups whose valuation crosses Rs 10 crore.

“Valuation limits set on a startup valuation of Rs 10 crore is too low and will discourage larger bets on building next set of unicorns in India. It’s a lack of vision in assuming all start-ups and angel investors will be small,” said Rahul Bhalchandra, co-founder and CEO, You Look Great – Bengaluru-based salon chain.

Vinamra Pandya who runs organic products marketplace Qtrove said that Rs 10 crore limit might not work since startup valuations are on paper and they change drastically based on marketing conditions and how the startup fares in the medium-to-long run.

“Startups with severe bandwidth crunch (as is normally the case) focusing just on this part would lead to overall value destruction.”

Streamlined process

In order to claim exemption as per the relaxed rules, startups and investors will be required to make an application via DIPP in a prescribed format along with the essential documents.

“The process is further simplified to take a step forward for ease of doing business in India. Startups wouldn’t be required to clearance from Inter-Ministerial Board set up by DIPP,” said Archana Khosla, founder partner at Mumbai-based law firm Vertices Partners.

“It is great that DIPP has taken the responsibility of forwarding the applications,” said Pranay Gupta, co-founder at co-working startup 91springboard.

Following which the Central Board of Direct Taxes (CBDT) will issue the exemption certificate within 45 days. This is expected to lend clarity if a startup’s application is granted approval or not.

“Through these changes, the entire tax exemption process will be expedited to just 45 days with far lesser and simplified documentation for startups seeking angel funding,” said Harshaavardhan Redi Sirupa, founder and managing partner, Namrata Hemp Company.

Moreover, startups need not seek fair market valuation certificate from merchant banker that was earlier mandated and consequently criticised by startups due to the high fees by merchant bankers instead of chartered accountants as barred by IT department last year.

Beyond definition

However, since the exemption only covers DIPP-registered startups, the startup community is looking at unregistered startups as well and those that are more than 7-year old (of the period as per the startup definition of businesses not older than 7 years). “Majority part of the start-up ecosystem remains out of reach of the benefits available vide the notification,” said Khosla.

This pushes most of the start-ups out of the exemption purview. That’s because out of around 7 million companies (including micro, small and medium enterprises) formed in India in the last 7 years, DIPP has so far recognized 15,384 startups so far.

“I understand not giving income tax exemption to startups that are more than 7-year old but all startups irrespective of their age need to raise funds. If they bootstrapped their first seven years and then raised funds later would they not be eligible to get support through DIPP?” said Gupta.

The revised guidelines, however, have now scrapped April 2016 cut-off for startups incorporated before that to apply for tax exemption after registration with DIPP.

“Registering with DIPP to avoid angel tax, which should not be there in the first place, is not there in any other country in the world. This assumes every entrepreneur is trying to launder black money,” said Ganesh.

“It should be the other way around, using all the current provisions of General anti-avoidance rule, KYC of investors, tax returns of start-ups, if there is any reason to suspect the startup,” added Ganesh.

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