Budget 2019 | Let’s enable the angels to keep blessing start-ups

SR Patnaik and Reema Arya

Imagine receiving a sum of money from someone as a capital investment and then immediately losing almost one-third of the same without any fault of yours. This is what the income tax department seems to be doing for a while with start-ups by taxing them on the capital raised by them in excess of what they perceived to be the prevailing market value of the company.

For the uninitiated, the provision was originally introduced in 2012 among a series of steps taken by the Centre under anti-abuse provisions with the intention to ensure that unaccounted money does not get mixed with legitimate money. The provision aimed at discouraging investments made in private companies at exorbitant values in the name of share capital and share premium, even though the financial statement of the company did not justify such high premium on share capital.

While the above approach may be valid in general, in the start-up industry, the valuation conundrum is significantly different. Generally, even though in the initial years, the start-ups may end up incurring huge losses, they command high valuations over the long term owing to the value of the ‘idea’ for which they have been set up. They generally receive the investments from a number of wealthy individuals, unlisted holding companies or private equity investors, etc. who invest for an ownership stake in the company. As the funding is received by start-ups from angel investors, this taxation has been popularly called as ‘angel taxation’. Many of them have become hugely successful and have become unicorns in their own right.

Yet, the start-ups in India have often found themselves on the wrong foot before the tax department, as the department had raised tax demands for the share capital issued at a higher valuation. The valuation submitted to support the valuation has been contested by the tax officials either by questioning them as abnormal or unrealistic valuations or by questioning the significant differences between the expected revenue/profits and the actual results.

It is relevant to recollect that Central Board of Direct Taxes (CBDT) had received several complaints from taxpayers of being subjected to undue harassment by tax officials in this matter and thus, it had issued a clarification in the beginning of 2018 advising officials to not adopt any coercive measures to collect such demands. Even after the issuance of the clarification, a survey carried out during the beginning of 2019 suggested that more than 2,100 start-ups (i.e. 73% of all start-ups) who had received angel funding since their inception, have received tax notices.

Initiating its actions in this regard, the CBDT issued a series of notifications in January and February making certain modifications and relaxations. While the notifications broadly aimed at increasing the threshold limit of funding received from domestic investors from Rs 10 crore to Rs 25 crore, amending the start-up definition by increasing the turnover limit for a start-up from Rs 25 crore to Rs 100 crore and substituting the approval with a self-declaration, a lot more needs to be done.

With the Union budget on July 5, a total removal of angel tax provisions so as to give an impetus to the growth of the start-up industry is expected. Start-ups being the new-age employment generators, the focus of the government should be to incentivise them rather than make them stuck in unwarranted litigation.

The process of getting the start-up recognised is also a tedious task and involves a lot of compliance and detailed filings to be made. Imagine being a small business and having to devote time and resources just to take care of such tax issues. The unnecessary burden of such compliance needs to be eased at the earliest.

The easing of the process will provide the desired support to the start-up ecosystem and is line with the intention of an entrepreneur-friendly business environment that the government plans to provide. One hopes that finance minister Nirmala Sitharaman provides the much-needed solace to this group of entrepreneurs.

SR Patnaik is partner and head – taxation, and Reema Arya is tax consultant, Cyril Amarchand Mangaldas. Views are personal.