Devil in the details: Why the angel-funding notification won’t help much

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Updated: January 18, 2019 7:16:13 AM

Tax circular on angel funding doesn’t help much and, in any case, only applies where tax orders not passed.

angel tax, start upsIf the government truly wants to help startups it needs to do a lot more, not in terms of giving them money, but in terms of getting out of the way.

When over a third of India’s 39,000 startups have received a notice from the taxman – according to iSPIRT, a think tank for the software products industry – asking them to pay taxes on the angel investment they have received, it is obvious there is a serious problem. More so given the fact that the government takes startups seriously and even has a Startup India policy to encourage startups and also a fund dedicated to them; that the fund hasn’t really taken off, though, is a testimony to how long it takes for government intent to translate into action.

These startups, according to Inc42 – a media platform dedicated to the startup ecosystem – have got a total funding of $38.5bn since January 2014 and are, today, valued at around $130bn, making it clear that the value they are creating is quite large; that, in turn, reflects the investors’ view that these startups are going to disrupt various markets with the new solutions they offer.

While, in principle, investments received by companies are not taxed, in the case of angel investors – their investment in startups is likely to be around $5-6bn so far – the taxman has apprehensions that this may be black money being routed into startups as a way to launder it; investments made by Sebi-registered funds, for this reason, are not taxed.

The argument never made sense since, once the money comes in through a bank – no startups are accepting large sums in cash – the money is traceable with the PAN and other such details available; indeed, startups could be asked to put down the PAN number of investors. To the extent the money is sought to be laundered, this can only be done if the startup gives most of this back to various front firms of the investor; since all of this will be by cheque, this too is easily traceable.

Despite this, however, since the tax notices were sent out, once the industry raised the issue forcefully, the government said it would set up a panel of IIT/IIM experts on the matter and, on Wednesday, clarifications were issued by the taxman – no tax would be levied on startups with a capital of less than Rs 10 crore or provided the investor had an income of over Rs 50 lakh and a net worth of more than Rs 2 crore.

This is a step in the right direction, but a grudging one. Why should a startup pay taxes if it gets more than Rs 10 crore in angel investment, and will this apply to just the amount over Rs 10 crore or to the total? And since at least a fifth of all angel funding is from friends and family, the Rs 50 lakh/Rs 2 crore criterion is a stiff one; worse, each time an investment is made by someone who is not registered with Sebi, the investor has to apply for an exemption for the firm he/she is investing in.

Theoretically, all investors – including corporates, since the tax exemption doesn’t apply to them if they are investing directly – can register with Sebi to solve the problem, but the idea is to make investment simple, not tough. Most interestingly, while the idea behind the clarification was to provide relief to the startup industry, the circular is clear that this doesn’t apply if the taxman has already passed an order. If the government truly wants to help startups it needs to do a lot more, not in terms of giving them money, but in terms of getting out of the way.

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