Quick Take | A DIPP notification on angel tax stops short of solving the problem

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Sounak Mitra

Indian startups turned optimistic that the angel tax may be history, after news of a recent government notification. The notification itself turned out to be a disappointment, leaving the angel tax sword dangling over startups.

The Department of Industrial Policy and Promotion (DIPP) issued a recent notification saying the changes will “ease availment of angel tax exemption”. But, there’s very little to cheer in it.

Firstly, the notification does not cover those startups that have already received assessment orders. The anguish expressed by these startups is why the angel tax issue came into the limelight. What is expected now is a series of court cases that could take years to reach a conclusion. And, startup founders will have to allocate time to fighting court cases rather than focus on the business.

Secondly, the notification covers only companies who have raised up to Rs 10 crore in aggregate. And, only people who have more than Rs 50 lakh annual income and net worth of Rs 2 crore can freely invest in startups. This exclude the ones that have already received assessment orders and are not covered under this notification.

The circular may be well intended by bringing in a globally accepted concept of an accredited investor, something that Indian investors had been asking for. But, it came with some rigidity. Globally, the entire investment is not taxable, unlike what the DIPP circular says. And, it’s either the income or the net worth that is considered. Both will be considered in India. And, it has set a glass ceiling of Rs 10 crore throughout the lifetime of a startup. That’s too low with this being the seed round funding in most cases.

Thirdly, there’s no reason for the Income Tax department to be so obsessed with domestic capital inflow to startups in India. Between 2014 and 2018, an estimated 10 percent of the $38.5 billion raised by startups came from domestic sources. If the angel tax is liberalised, more domestic capital may flow into India’s startup ecosystem and potentially help create jobs – an area the Government has been keen to address.

While the angel tax was initially proposed to arrest alleged money laundering, there is no evidence to suggest that startup funding has been a conduit for illegal activity. Rather, if the Government decides to keep startups and investors out of the tax net at the time of investment, India’s new economy could benefit from investment inflows.

Lastly, a tax on investments is counterproductive. These investments are used for creating assets and to expand the business, which eventually generates income, which is then taxed. So, the Government may actually be introducing an investment tax in the guise of income tax on angel investments.

Eventually, when investors exit at a profit, they will have to pay tax. There is no rationale on why they should be taxed at the time of making investments. In any case, the concept of angel tax does not go in line with the current government’s Startup India initiative. Creating a strong angel investment ecosystem, by providing incentives, like many other countries do, would help Indian the startup industry and the economy as a whole.