Startups and VCs cheer the 'Reform and Rationalize' Budget

A long-standing ask of Indian startups has been to plug the capital gains differential between listed and unlisted securities.

The first budget of the new NDA government has set the tone for the current financial year. Budget 2024 has bestowed upon startups many of the key asks they had of the government. The changes proposed by the honorable finance minister will have a tangible impact on Startup India as well as investors in such assets.

Removal of Angel Tax

The biggest reform announced for startups was the removal of “Angel Tax”. Introduced in 2012 as a means of preventing the circulation and generation of unaccounted funds, Section 56(20(viib) was dubbed “Angel Tax” as it primarily applied to angel and seed round investments by Indian residents. Non-residents were outside its purview.

Angel tax sought to tax the difference between the price at which securities were issued by a startup to investors vs the fair market value of the securities. What was meant as an anti-abuse measure slowly became a tax-harvesting section as many startups began to get tax notices for their raises. The taxman’s penchant for comparing the actual performance of the company against the projections and taxing the difference was patently absurd. Even the government provides revised estimates every budget, making this practice of the taxman repressive. Not adhering to projections is a commercial risk, not a taxable event.

The extension of Angel Tax to non-resident investments in 2023 saw startup funding plunge 67% YoY to a 6-year low.

Rather than the previous tinkering with angel tax seen in 2019 and 2023, the wholesale surgical strike against angel tax without any exceptions is a massive win.

Though it only applies to funding rounds post April 1, 2024, the industry holds out hope for 2 more announcements:

1) Dropping ongoing Angel Tax cases against startups

2) No notices to startups who raised capital prior to April 1, 2024

But after 12 long years, Angel Tax is finally dead.

Parity in Capital Gains

A long-standing ask of Indian startups has been to plug the capital gains differential between listed and unlisted securities. Investments in unlisted securities are mainly primary capital infusions, which goes into new asset creation, hiring and sales. The stock market is the transfer of capital from one investor to another. Despite this, the tax rate on unlisted securities was twice the rate of listed securities. The tax rate for foreign investors was also twice the rate of domestic investors. Due to this, funding in startups has primarily been from foreign sources. Hence when the stock market was booming, starting funding entered a prolonged funding winter.

The parity between listed and unlisted as well as resident and non-resident investors will boost startup funding.

Even with the Cost Inflation Index removal, startup investors are far better off than the old regime. The Cost Inflation Index table as released by CBDT gives an average indexation benefit of 5.76% to resident Investors from 2001-02 to 2023-24. But The 37.5% reduction of LTCG on unlisted shares, from 20% to 12.5% is still a major boost to post-tax returns as compared to the erstwhile regime of indexation. Indexation benefits were not large enough to compensate for the unlisted tax rate which was twice the rate of listed securities.

This Budget has cemented Prime Minister Modi as the “Startup PM of India” and these changes will fuel startup fundraising and expansion. The Government has been imploring the private sector to increase investments. These changes will ensure that startups lead the charge.