Introduction
A contentious tax policy in India known as the ‘angel tax‘ has been criticised for purportedly restricting investment in new businesses. In 2023, the government modified the angel investor tax system to include non-resident investors. Others assert that it is essential to ensure that all investors are treated equitably, despite claims that this inclusion would discourage startup investment. The reception of this proposal has been mixed. This article will discuss the change to the angel tax system and its potential effects on businesses. In addition, it will consider the arguments for and against the modification and offer suggestions for how the government can improve the angel tax system in the future. The modification to the angel tax system is a major reform that will have significant effects on enterprises. Understanding the repercussions of this modification and how it will affect the launch environment is essential. In addition to discussing some of the primary arguments for and against the amendment, this article will provide an overview of the proposal and its potential consequences.
Existing Provisions under Income Tax Act related to Angel Tax
A provision of the Income Tax Act of 1961 known as the “angel tax” assesses the difference between the issue price and the fair market value of shares when a closely held corporation offers them to a resident investor. This clause was added in 2012 to restrict the use of unexplained funds for startup investments.
The angel tax is calculated as follows:
Taxable amount = Issue price of shares – Fair market value of shares
The current tax rate is 30%. The issuer of the shares is responsible for the tax payment. The angel tax is a controversial provision. Others argue that it is essential to ensure that all investors are treated equitably, whereas others argue that it discourages venture investment. Currently, the angel tax applies to all closely held businesses that sell shares to residents. However, the Finance Bill 2023 proposes amending the clause to include non-resident investors. This modification is anticipated to go into effect on April 1, 2024. There have been divergent reactions to the proposed angel tax amendment. Others argue that it is important to ensure that all investors are treated equally, whereas others argue that it would discourage non-resident investors from investing in companies. It is uncertain how the proposed change would affect the startup environment. Nonetheless, it is evident that the modification will have a significant impact on how businesses seek funding from non-resident investors.
Reverse Flipping
A procedure known as “reverse-flipping” allows an Indian startup to be acquired by a foreign company. This is done to take advantage of the tax benefits provided by the foreign jurisdiction. Due to the eradication of the angel tax on contributions from non-resident investors, the proposed change to the angel tax may enhance the attractiveness of reverse-flipping for companies. This is because the angel tax applies only to investments made by inhabitants. It is essential to keep in mind that a startup’s decision to reverse-flip may also be affected by other factors. This includes the tax laws of the other country, the cost of reverse-flipping, and the overall business plan of the venture. It is unclear how the intended angel tax adjustment would affect reverse-flipping as a whole. Startups and investors equally should consider this potential effect.
Enhanced Oversight
The Financial Act of 2023 has enhanced the ITA’s (Income Tax Authorities) control over angel tax in a number of areas. These encompass:
- Increased scrutiny of the investments of non-resident investors. As a consequence of the Act, startups must now obtain an ITA certificate before offering shares to non-resident investors. This certificate will attest to the legitimacy of the investment and the fact that the startup did not use it to avoid paying angel tax.
- increased investigative authority for the ITA. The Act authorises the ITA to investigate firms and investors who may be in violation of the laws governing angel investing. This includes the power to conduct inspections, seize documents, and compel witnesses to testify.
- Increased penalties for rule violations. The Act increased the penalties for violating angel tax regulations. This is punishable by a fine of up to INR 10 lakhs for business owners and up to INR 5 lakhs for investors.
- The increased ITA angel tax scrutiny is intended to deter companies and investors from violating the law. In addition, it seeks to ensure that the angel tax system is applied uniformly and efficiently.
References
1. ‘Angel tax in India: a retrograde step for foreign investment’ (2023) International Tax Review, p. N.PAG. Available at: https://search.ebscohost.com/login.aspx?direct=true&AuthType=ip,sso&db=bsu&AN=163585989&site=ehost-live.
2. ‘India’s start-ups fear extinction from “angel tax”’ (2019) FRPT- Software Snapshot, pp. 18–19. Available at: ‘India’s start-ups fear extinction from “angel tax”’ (2019) FRPT- Software Snapshot, pp. 18–19. Available at: https://search.ebscohost.com/login.aspx?direct=true&AuthType=ip,sso&db=bsu&AN=135725169&site=ehost-live
3. Mukherjee, A. (2019) ‘Angel Investors Are in Tax Hell in India’, Bloomberg Opinion, p. 25. Available at: https://search.ebscohost.com/login.aspx?direct=true&AuthType=ip,sso&db=bsu&AN=134392345&site=ehost-live .
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