The exclusion of jurisdictions like Singapore, Mauritius, Cayman Islands and Netherlands, which comprise a bulk of the foreign direct investment (FDI) into Indian startups, from a white list of geographies that are relieved from angel tax provisions, could exacerbate the ongoing funding winter in the sector, according to venture capitalists.
On May 24, the Central Board of Direct Taxes (CBDT) notified that investments from 21 countries will be exempt from angel tax. These include Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland. Other countries like Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the United Kingdom and the United States were also included in the same list.
But regions like Singapore, Mauritius and Cayman Islands, all three that figure in the top seven sources of FDI into India, not exempt from the ambit of angel tax, which raised concerns among investors.
"The implication of this (notification) is that the funding winter will end up getting even more protracted because the clarity that people were seeking has not fully come through. Investors will be reluctant to invest under the risk of 25% of their capital being subject to tax," Siddarth Pai, founding partner, 3one4 Capital said.
Fears of a prolonged funding winter were largely because even investors from exempted jurisdictions like the US, Austria etc opt to invest in India through Mauritius, Singapore and the rest, as part of their Asia strategy.
This move days after comes after startup investors hailed the finance ministry’s proposals to exclude certain parties, like pension funds and sovereign wealth funds, from the ambit of the angel tax last week.
Even other entities with direct or indirect government ownership of 75 percent or more, were proposed to be exempt from the provisions of angel tax, an earlier notification from the Central Board of Direct Taxes had said. It also provided more flexibility in accounting for valuations in what had come as a relief for new-age companies that are trying to navigate their way out of a tight capital market.
"The industry will now attempt to reach out to CBDT and the government to understand if there are additional protective measures that we can put in place to allow investments from Mauritius and Singapore to come into India without being taxed under 56(2)(viib)," Pai at 3one4 added.
According to Section 56(2) (viib) of the Income Tax Act, the difference between the fair market value and the face value of shares issued by a company should be taxed.
Some industry players however supported the move. "Places like Singapore, Mauritius, Cayman Islands and the Netherlands are notorious as pooling destinations. Singapore has a deep relationship with Chinese investors," a startup investor said.
The angel tax regime was originally started in 2012 as an anti-abuse measure to prevent money laundering. It mandated that a startup’s fundraise could be taxed whenever the funding round happened at a valuation more than the fair value of shares – as determined by a merchant banker.
"For a foreign fund - everything is an intrusion...Each tax system is different and the ethos of each place is different. You have to play by the rules. The exemptions are consistent. No government will block genuine investment flow into the country..." the investor added.