Abolish angel tax on startups, finance ministry’s DPIIT request – CNBC TV18

Addressing the media on Thursday (July 4), DPIIT Secretary Rajesh Kumar Singh said that the recommendation to remove angel tax was made on the demand of startups, but the final decision rests with the Union Finance Ministry.

The ministry’s proposal also came after the Confederation of Indian Industry (CII) in its budget recommendations called for the removal of the angel tax, saying it would “go a long way in capital formation”.

The industry clamor to scrap the tax has been long-running and has gained momentum amid the ongoing funding slump, with investment in startups falling to a five-year low in 2023.

Venture capital investors also believe that the abolition of the angel tax will accelerate the inversion process — Indian startups moving their domicile to India — and boost innovation in the world’s third-largest startup economy.

What is angel tax?

Section 56(2)(viib) of the Income Tax Act – commonly known as Income Tax – originally introduced in 2012, is an anti-abuse provision to prevent practices such as money laundering and racketeering.

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This rule applies when a closely held company, such as a startup, issues stock (including preferred stock) at a value higher than fair market value. The tax authorities consider the additional amount received by a startup as income from other sources and levy a tax of around 30% accordingly.

In protesting the tax, investors argue that given a startup’s future potential, they typically invest at a higher valuation, and tax notices to their portfolio companies hinder their “ease of doing business.”

Of course, despite the colloquial name, angel taxes are levied on startups, not their investors.

Union Budget 2023-2024 summary and concerns raised from it

Earlier, this tax was applicable only on money raised by startups from Indian investors and funds that were not registered as Alternative Investment Funds (AIF).

Union Budget 2023 expanded its scope to include foreign investors, raising concerns among venture capital funds registered abroad. The purpose of the amended rules was to bridge the gap between the rules contained in the Foreign Exchange Management Act (FEMA) and the Income Tax Act.

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Subsequently, the Central Board of Direct Taxes (CBDT) issued a circular under which investors such as sovereign wealth funds and pension funds from 21 countries including the US, UK and France were exempted from angel tax for non-resident investment in non-resident Indian startups.

However, the list excluded investment from countries such as Singapore, the Netherlands and Mauritius, which account for a large share of investment in Indian startups.

Venture capital investors registered in non-exempt countries find the move counterproductive as 75% of FDI investments in Indian startups are from foreign investors.

The Indian Venture and Alternative Investment Association (IVCA) says it has submitted proposals to the government to expand angel tax exemptions in real terms.

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Further, IVCA has requested that foreign venture capital investors registered under SEBI Regulations, 2000 be treated as exempted entities.

Who is exempt from angel tax?

The CBDT has clarified that its assessing officers will not examine DPIIT-registered startups for Angel Tax cases.

According to this notification, any investment – ​​whether foreign or domestic – received by startups registered at DPIIT will not attract Angel Tax. By July 2024, there are about 140,000 startups registered at DPIIT.

In order for a startup to secure its registration, it must have a turnover of less than that ₹100 crores in each of the previous financial years. It should be noted that the applicant entity is considered a startup only up to 10 years from the date of its establishment.