Startup Inc suggests measures to soften angel tax blow of Budget

The angel tax regime was originally started in 2012 as an anti-abuse measure to prevent money laundering. (Representative image)

Industry bodies of startups and venture capital investors have suggested a raft of measures to the Central government so that its move to include investments from foreign investors under the ambit of angel tax doesn’t hurt start-up funding.

The measures suggested include excluding investments from foreign companies, PE/VC funds, sovereign wealth funds, endowment funds and hedge funds recognised by International Organization of Securities Commissions (IOSCO) from the angel tax regime, apart from financial institutions like banks, insurance companies, asset management companies, portfolio managers, wealth advisors and investment advisors.

If the funding winter was not enough of a problem, the government threw another curveball at startups with its Union Budget. This is because an exemption for money raised from foreign investors under the angel tax regime has been done away with in the Finance Bill, 2023. However, the exemption for investments made by SEBI-registered alternative investment funds still continues.

According to experts, the new tax provision could severely dent startup investments in the country by foreign investors such as SoftBank, Tiger Global, Alpha Wave and Sequoia.

“As per Section 56(2)(viib)(ii), the Central Government may notify class or classes of persons to whom this section 56(2)(viib) will not apply. Using this power, the Central Government must consider exempting classes of persons who are at a lower risk of circulating unaccounted money due to the stringent regulation they’re subject to, similar to entities regulated by SEBI or IFSCA,” said an industry representative aware of the representations made to the government.

The angel tax regime was originally started in 2012 as an anti-abuse measure to prevent money laundering. It mandated that a start-up’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.

As the premium on valuation of shares is one of the most contentious things in the angel tax issue, industry bodies have also sought a revision of the relevant angel tax rules of determining valuation. As opposed to the current requirement of a discounted cash flow valuation, a change to “internationally accepted valuation methodologies” has been asked for.

In order to make it harder for bad actors to abuse the concessions made for startup investments, the industry bodies have also proactively suggested more stringent rules.

These include mandating that securities of startups have to be held in dematerialised form and not registering any transfer of shares for cash, but only via cheques, demand drafts, banking channels or other such electronic means.

Over the years, startups and investors have raised an alarm about being troubled by the taxmen due to the provision even in the case of genuine investments. Startups have said that they received tax notices on angel investment raised 3-4 years prior. In some cases, the sum that the startups must cough up as tax and late payment fee even exceeded the original funding amount.

At the height of the angel tax conundrum in 2019, a survey by LocalCircles showed that over 73 percent of startups that raised capital between Rs 50 lakh to Rs 2 crore in India have received angel tax notice(s) from the Income Tax Department.