Angel tax is turning out to be a major headache for start-ups in India. The country has already evolved in terms of its start-up environment and the Government has come up with initiatives like Startup India, Stand Up India and Make in India. Yet, angel tax continues to be a major worry for companies that have set up shop in the country.

7 core aspects of angel tax

Here’s taking a look at the 7 aspects of angel tax that start-ups should definitely learn more about-

1.     Angel tax is a tax of 30.9% that is imposed on investments that are made by external investors in companies/start-ups. The full investment is not taxed and only the amount considered above fair value(valuation) of the start-up is taken into account and classified as income from other sources under the Income Tax Act of India.

2.     The main issue arises when there is subjective valuation of start-ups based on aspects like discounted cash flows without considering intangible factors like goodwill. This leads to varying interpretations of the term fair value and makes start-ups more vulnerable towards suffering from taxes that are unfairly stratospheric and when the income tax authorities decide that investments are high above their valuation.

3.     Angel tax goes back to the year 2012 when in the Union Budget, Pranab Mukherjee, the then-Finance Minister, announced the Finance Act of 2012. This tax has already forced several angel investors to refrain from investing in budding start-ups and has become a major roadblock for several start-up entities in the country already.

4.     Multiple reports have emerged of entrepreneurs having to undergo examination by income tax authorities on account of valuation of the funding that they received. This has already led to a sharp decline in angel funding in the country which slid down to 191 in 2017 from 291 in 2016.

5.     Venture capital firms are exempted from angel tax on their investments so that is one way forward that start-ups can probably consider.

6.     The Government junked angle tax on funding for start-upsbut the definition of this term is only applicable in case an entity remains valid up to 5 years from its registration/incorporation and turnover for any financial year does not cross Rs. 25 crore. As a result, investments in all start-ups are not eligible to get this exemption. This exemption does not also apply to retrospective funding.

7.     Start-ups now have to provide a portion of funding received from their investors. Notices are given to angel investors and start-ups alike under Section 68 of the Income Tax Act with regard to unexplained income that attracts tax penalties. This has led to seed funding transactions and angel investments coming down by 40%.

This angel investment tax prevents investors from funding early-stage and budding companies and has led to a decline in investments as mentioned above. This also deters several budding entrepreneurs from successfully starting their own businesses in India. It is important for several early-stage and unlisted start-ups to raise funding from angel investors in order to build the foundation for garnering funds in the future from venture capital firms or groups. Several petitions have already been dispatched to the Government for completely doing away with angel tax.

This assumes more importance in the global context when one considers how other countries are incentivizing start-ups with favourable taxation policies and other benefits. China is famous for start-ups like Alibaba, Tencent and Baidu that have truly hit it big. There are good tax policies which enable 70% of investment to be deducted from taxation two years post investment in high-tech start-ups. Singapore also offers incentives including $200,000 in tax exemptions for first three years of assessment. In case of Europe, there are attractive incentives on offer for start-ups and investors alike while Australia has reportedly been called the most generous country in this regard.

In the 2018 Union Budget, Finance Minister Arun Jaitley did not touch on the angel tax subject. This has created further uncertainty with regard to the future. With another Budget on the anvil, start-ups and investors are hoping for support from the Central Government in order to keep India’s start-up dreams alive and ticking.