What Is The Angel Tax Controversy?

Who is an angel investor?

An angel investor invests his own money in an entrepreneurial company. He does this to earn a higher return on his money. A number of startups are looking for investments to grow and expand business and this is where angel investors come in.

What is angel tax?

Angel tax is a 30% tax which is charged on the funding, startups receive. The angel tax (this is a 30% tax), is levied when startups receive funds from angel investors at a valuation, higher than ‘fair market value’.

The funds startups receive from angel investors are considered Company Income and this is taxed. Angel tax was introduced way back in 2012. The main purpose of angel tax is preventing money laundering.

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What Is The Angel Tax Controversy?

Why is angel tax problematic?

Let’s understand why angel tax is so problematic. Many closely-held unlisted private Companies receive funds from angel investors. It is believed that these Companies artificially inflate the value of their shares (Raise their valuations) without realistic or a sound financial basis.

The investments startups receive from angel investors are made at a premium to the fair price. The tax authorities want to tax the amounts raised in excess of the fair value as angel tax. This is the angel tax controversy.

Angel tax was introduced by the then Finance Minister Pranab Mukerjee way back in 2012 in the Union Budget. The amount was called “income from other sources” and taxed under Section 56(2)(viib) of the Income Tax Act. The angel tax was a hefty 30.9%. Angel tax was charged not just to private Companies, but also to start-ups which seek early-stage investments, from angel investors in India. Startups have few sources of funding and want angel tax removed.

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So what’s the controversy of angel tax?

The controversy is vis-à-vis the valuations during the rounds of startup funding. Many start-ups have reducing or stagnant revenue. In spite of this the valuations have increased. The taxman is raising these questions? He is questioning the premiums paid by angel investors and wants to categorize this as income. The angel tax would be 30% on share premium received beyond the fair value.

Tax officers had written to banks and attached bank accounts of several startups. This was the controversy of angel tax.

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Governments stand:

The tax department is questioning the valuation experts. The Department of Revenue (DoR) has asked assessing officers not to take forcible steps to recover angel tax from registered startups. Unregistered start-ups could still be under the scanner. The income tax officials are asking why someone would pay huge amounts in investment, when the real value of the startup is much less. The purpose could be converting black money to white money.

The way forward:

The Government has come up with a new way to define a startup to douse the raging angel tax controversy. Suresh Prabhu, the Minister of Commerce and Industry, has said an entity can be considered a startup, up to 10 years from the date of incorporation. Currently, its 7 years. The Government wants to simplify the process of exemptions for Startups under Section 56(2) (viib) of the Income Tax Act. Section 56(2) (viib) of the Act was also called angel tax.

• An entity is considered a startup if its turnover in any financial year since registration has not exceeded Rs 100 Crores. This used to be Rs 25 Crores.
• The consideration for shares, eligible startups receive, (This is for shares issued or proposed to be issued) by all investors, is exempt up to an aggregate limit of Rs 25 Crores.
• All investments into eligible startups by NRIs, Alternate Investment Funds – Category I, registered with SEBI is exempt under Section 56(2)(viib) of Income Tax Act up to Rs 25 Crores.
• The share premium must not be invested in land or residential building apart from those held as stock in trade or occupied, rented or used by the business.
• The startup/entity cannot invest the premium into shares and securities, jewelry or cars/vehicles priced at Rs 10 Lakhs or above, other than those used in the ordinary course of business.

The Government has clearly sent a message that it wants India to be the World’s startup hub. That’s why it’s increasing the turnover from Rs 25 Crores to Rs 100 Crores. This is the foundation of Startup 2.0.

Startups in India can breathe a sigh of relief. Angel tax was a dampener and many startups had started migrating abroad. Many startups take years to break even and subjecting the funds received from angels as taxable income was unnecessary. This helps startups focus on core activities. 

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