Angel tax, a direct tax imposed on some start-ups but before we start discussing on Angel tax we need to get back a few steps to understand it in a better way. Start-ups born from entrepreneurial dreams. Now, who can be a certified start-up? If you want to certify your firm as a start-up as per Government of India entrepreneurs needs to match the following criteria:

  • Either firm is registered under Company Act 2013 or Partnership Act 1932 or Limited Liability Partnership Act 2008
  • The firm should not exceed 10 years of operation after it’s registration.
  • After registration of the firm, the revenue should not exceed 100 crores.

Recently Government of India given some relaxation to the firms which we will discuss later.

In recent few decades government also supports these ventures as these start-ups generate lots of employment opportunities, it helps in capital creation and it also leads to technical advancement. Start-up India, Make in India and others are the live example of government to influence and support the start-up entrepreneurs. But at the initial stage, entrepreneurs face a huge challenge of funding. Banks do not want to fund as in many cases they are not sure enough about the concept of the venture or found it much risky. Venture capitalists also deny to support at the founding stage, they want to invest at post launching stage. In this crisis situation, few investors come to give the entrepreneurs financial support. These investors are known as Angel investors. Angel investors are those individuals who have enough wealth to invest in their own capacity or through crowdfunding platforms to bring the capital for the start-ups and the investments by Angel investors are regulated by SEBI. These angel investors come at a stage when the entrepreneur has been refused by both banks and venture capitalists and in return of the investment they get shares of the start-up as per company valuation and their funding ratio. If the value of share received by the entrepreneur is equal to market value then it is perfectly fine but in case the entrepreneur receives the excess value of share than its fair value then the act of Angel tax comes in. Actually, in many cases, Demons comes in the disguise of an Angel investor to convert their black money into white, thus in the year, 2012 Government Of India introduced Angel Tax under section 56 of the income tax act to curb the problem of money laundering.

ANGEL TAX: ANGEL or DEMON

Now come to the details, Angel Tax is a direct tax refer to the income tax payable on capital raised by the start-up firms via the issue of shares where the share price is seen higher of the fair market value of the shares sold. It was introduced in 2012 by Mr.Pranab Mukharjee, who was the finance minister at that time. The main reason behind this to prevent money laundering and to identify unexplained cash credits. As per section 56(2)(viib) of the income tax act, the amount raised by a start-up in excess of its fair market value would be treated as income from other sources and would be taxed at 30.9%. Assuming that their business will grow rapidly, valuation mostly is done on the basis of overrated future projections but at the time of tax assessment, the tax authority value the business based on figures actually received (rule 11U and 11UA of income tax act). Now if the actual figure reaches the projection then ok but if the actual figure is unable to reach the projection, the excess amount of share premium is treated as income of the investee. How to calculate the Angel Tax? For example, if the fair market value of a share is Rs.100 but the investee gets Rs.150 for the share from the angel investor, now investee have to pay 30% of the excess amount as Angel tax that means (150-100)*30.9%=15.45.

Applicability

This Angel tax is not imposed on non-resident or venture capital funds, actually, it is applicable only on the investments made by the resident investors.

Criteria for Angel Investor

Government of India also imposed some criteria on investors. An angel investor must match those criteria to invest in any start-up.

  1. As angel investors net worth should be 10 times greater than his investment. For example, A, whose net worth is 50 crores, he wants to invest in a start-up up to 5 crores, he can however B whose net worth 45 crores he cannot invest in a start-up 5 crore.
  2. Previously as per notification by the Department for Promotion of Industry and Internal Trade, an angel investor picking up stakes should have minimum net worth of INR 2 crore and should have average return income not less than 50 lakh in last 3 years now to give some relaxation government announced an entrepreneur raises INR 5 lakhs from any investor, the amount will be taxed unless the relatives had the income of INR 50 lakhs per annum or net worth of Rs 2 crores.

Now come to the details of the purpose of Angel tax. Why Angel tax imposed? Angel tax imposed to prevent the money laundering and also to identify unexplained cash credits. For example, A is investee and B is an Angel investor with huge black money, B invests his black money in the venture to make the money white. Here Angel tax imposed to prevent the money laundering. Another purpose of Angel tax was to discourage the practice adopted by the taxpayers of subscription to shares of closely held companies at an unjustified premium compared to its fair market value then a notice is sent under section 68 which is for unexplained cash credits, to understand the situation we should go through the case of travelkhana and baby gogo issue, where the income tax department sent them notice and frozen their bank account. Astarc Ventures-backed TravelKhana, which received no response to its appeal against the December tax notice and request for an abeyance order, says its accounts were frozen and Rs 7.5 lakh withdrawn from one of them. TravelKhana, owned by Delhi-based Duronto Technologies Pvt. Ltd had received a notice from the income tax department for the undisclosed amount raised in 2015. As per Pushpinder Singh, co-founder of TravelKhana, the government had frozen three accounts of the company with ICICI Bank and one in State Bank of India. Babygogo, a child healthcare website, acquired by Sheroes, a women career platform, in December 2017, got fewer taxation scars as most of its business takes place through parent company Sheroes’ accounts. Babygogo had received a taxation notice in December for a funding round of Rs 2 crore raised in October 2015. The company received a message that the balance in its account stood at minus Rs 72 lakh after withdrawal by the income-tax authorities

Now start-ups can avail exemption from angel tax if they go through a specific procedure prescribed by the government. Eligible start-ups request Department of Industrial Policy and Promotion with application supporting departments, then the application of the Department of Industrial Policy and Promotion recognized start-ups will be forwarded to the Central Board of Direct Tax along with attached documents and then if Central Board of Direct Tax accepts the application, no angel tax will be charged on that start-up. Start-ups and their investors who provide requisite declarations on their returns will not be subject to scrutiny under the angel tax on the share valuation, investors and their sources of funds will be e-verified, lower scrutiny of valuation by the tax officials has been extended to start-ups that get funding from alternative investment funds like real estate fund, PE fund, fund for distressed assets. But start-ups should not purchase immovable assets, transport vehicle above 10lakh, loans, and advances to avail exemption of angel tax.

Though the government introduced Angel tax to prevent money laundering, it has some adverse effects. India is one of the biggest start-up ecosystems, in 2018 the number of angel investors reduced in a huge number, ) which is not a very good sign for the start-up ecosystem. As there is the burden of criteria for angel investors it Discourages local small Indian investors, which is another drawback of Angel tax. Start-ups are starved of capital due to lack of investors, many promising start-ups with unique ideas may be ruined by this angel tax. Now another issue, valuation of an old firm is easy to calculate but in case of start-ups it is not so easy, the value in maximum time calculate on rosy future projections, the tax officials may found the share premium high, but how it proves the invested money is black money.

Angel Investment Scenario in India

The government wants to discourage misuse of start-up funding, it is understandable, it imposes the tax in the hands of the start-up, in the form of Income from Other Sources, this is discouraging the newly born entrepreneurs. If the goal is to eliminate illegal funding, should try to trace the transaction back to the investor assessee, and tax the surplus investment in his hand. It will reduce both compliance workload and notices received by start-ups but also gives them the encouragement that the amount received at higher valuations would not be subject to unfair taxation, and be available for use, in full.

Country is in that high time when we are moving towards greater opportunities for businesses in India in a positive and stable way, through Make in India, establishing a Fund of Funds for start-ups, few relaxations relating to Angel Tax may help India in building more friendly start-up ecosystem and boosting the funding flow, while also promoting healthy practices among investors.

Investors invest a lot of money in start-ups with huge risk and uncertainty, if we give them a bit of freedom, who knows one day the start-up may become one of the highest taxpayers of the country.

REVIEW & RESTRUCTURE

Start-ups generate employment, it helps in technical advancement and helps in many other ways which actually helps to build a strong economy structure and it can not be overlooked. To help start-ups in angel tax issues government reviewed and relaxed angel tax to some extent. The age limit of start-up increased to 10 years which will surely help the start-ups a lot. And as we discussed earlier the revenue limit was 25 crores to be certified as a start-up but now the limit issue is almost axed as the limit increased to 100 crores in case of unlisted firms and in case of listed firms having net worth above 100 crore or annual turn over of Rs.250 crore will be exempted from any such limit In case of start-ups not recognized by the Department of Industrial Policy and Promotion normal inquiry to be carried out and inquiry only after approval of the supervisory officer. This restructures give breath to the start-ups for sure (Ref:

CONCLUSION

In the end, it can be said that this relaxation given by the government is enough to encourage the start-ups and the angel investors, it will help to prevent money laundering without interrupting the operation of start-ups. Though few investors and entrepreneurs are not finding it perfect as we know there is a huge amount of black money present in our country, we just can not erase Angel tax from income tax act, as it may help Demons to convert their black money into white. Everything has its own pros and cons like angel tax, we should adjust it at best possible way to balance it, but it can not be omitted, omitting angel tax may encourage few people to do some financial corruption through start-up ventures. By the statements in media of K.Ganesh, investor, Big basket, it is clear that he is satisfied enough with the recent changes made by the government. Likewise, the statement of Rehan Yar Khan, managing partner, Orios venture partners, on media is also clear, he is happy with the restructured angel tax and now he has no complaints against it. So, in general, we can say that at present scenario both investors and entrepreneurs have no complaints against the restructured angel tax. But we all know nothing can satisfy everyone, for example, Mr.Siddharth Pai, Founding partner of 3one4 capital, his statement on media shows he maybe not quite happy as others as angel tax still exists now the point is as start-ups can generate employment, boost technical advancement, can help in capital creation government taking several steps to encourage entrepreneurs and angel investors, restructured angel tax relaxed maximum of angel investors and start-up entrepreneurs, as they are finding it much easier. But to satisfy everyone if we demolish the angel tax, it may encourage money laundering. But at the end, time will tell the effects of newly restructured angel tax and we all know nothing is permanent, in future angel tax may go through some more amendments for betterment.

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Qualification: CA in Practice
Company: CRA & Associates
Location: Noida, Uttar Pradesh, IN
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