Who are angel investors?
- Angel investors (also called informal investors, angel funders, private investors, seed investors or business angels) are affluent individuals who inject capital for startups in exchange for ownership equity or convertible debt
- These investors invest their money in an entrepreneurial company unlike institutional venture capitalists, who invest other people’s money.
- Unlike venture capitalists and bankers, many angel investors are not motivated solely by profit. They may be motivated as such by the enjoyment of helping a young business succeed as by the money they stand to gain.
What is Angel Tax?
- Introduced in the Finance Act of 2012, the angel tax is aimed at curbing money laundering through the purchase of shares at a high premium.
- Angel tax of about 30% plus applicable cess is levied on the amount that exceeds the fair market value of shares issued by unlisted companies, which is treated as income from other sources.
- Angel tax is levied on investments made by external investors in startups or companies. To clarify, the entire investment is not taxed – only the amount that is considered above “fair value” valuations of the startup, classified as ‘income from other sources’ in the Income Tax Act of India.
Legal Position of Angel Taxation in India
There is a section 56(2)(viib) of the Income tax act 1961, which states that:-
- when a closely held company issues equity shares and
- any investor subscribes for such shares and
- pays such consideration per share which is above the fair value of such shares,
- then such excess i.e. (Consideration per share less Fair Value per Share) is to be treated as income from other sources of such receiver company and
- Consequently such company has to pay tax on such excess amount @ 30% plus cess as applicable.
This section is the core of Angel Taxation. Simply speaking
- when this section becomes applicable to a closely held company and
- such company is a startup company,
- then tax paid on such excess receipts is termed as Angel Tax and
- Similarly the persons investing in its shares are termed as Angel Investors.
Bare section is also required to be referred as follows:-
As per Section 56(2)(viib) of the The Income Tax Act 1961, where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares
Provided that Section 56(2)(viib) shall not apply where the consideration for issue of shares is received—
(i) by a *venture capital undertaking from a venture capital company or a venture capital fund; or
(ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.
*Venture Capital Undertaking/Company is the one which has received certificate of registration (as applicable) from Securities and Exchange Board of India and complies with prescribed conditions as prescribed in explanation to Section 10(23FB).
Meaning of Fair Market Value
Now the question arises as to what constitutes Fair market value of shares.
Below is the extract of the explanation to clause (viib) of sub section(2) to Section 56-
The fair market value of the shares shall be the value—
- as may be determined in accordance with such method as may be prescribed (Rule 11U and 11UA) or
- as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature,
whichever is higher
- Rule 11U of the income tax rules provides for the meaning of expressions used in determination of fair market value while following methods prescribed under Rule 11UA of the income tax rules.
- Rule 11UA, on the other hand, provides for methods of determining fair market value of a property ,other than immovable property, including valuation of:-
- Archaeological collections, drawings, paintings, sculptures or any work of art
- Shares and securities (both quoted and unquoted
Reliefs to Angel Firms
Notification no. G.S.R. 364(E) issued on 11th April 2018. In this notification following matters were considered:-
- Definition of Startup:- An entity up to first 7 years (10 years in case of biotechnology sector) of incorporation (including Pvt. Company or Partnership firm or LLP) + Turnover for any year since incorporation is not exceeding Rs. 25 crores + Entity in business as may be prescribed.
- Exemption from Section 56(2)(viib):-
- Aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed Rs. 10 crores
- The investor/ proposed investor, who proposed to subscribe to the issue of shares of the startup has, —
- Average returned income of Rs. 25 Lakhs or more for the preceding 3 financial years; or
- Net worth of Rs. 2 crores or more as on the last date of the preceding financial year
- Startup has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.
Conclusion to Angel Taxation issue
Though by way of above notifications, CBDT has provided exemption to eligible startup businesses but then “Angel firms” are receiving multiple notices from department asking them to pay their outstanding “Angel tax dues” and further to furnish details on their source of income, their bank account statements and other financial data.
On the other hand, valuation of startups is also a major problem since industry demands Discounted cash flow (DCF) method to be applied instead of Net Assets Value (NAV) method. The valuation of a startup is usually based on a commercial negotiation between the company and the investor, and it depends on the company’s projected earnings at that point in time. However, since startups operate in a highly uncertain environment, many companies are not always able to perform as per their financial projection. Equally, some companies exceed the projection by a long mile if they are doing well.