Startups are of great significance for any economy as they are collectively one of the major emerging source of revenue and employment. Many governments from across the world have been going out of their way to facilitate the entrepreneurial dream. Even India took initiative to support startup dreams by means of its flagship ‘Make in India’ programme and a plethora of other schemes like ‘Startup India’ has been launched, but the “Angel tax” haunts startups and angel investors. The issue took a darken turn when several startups have faced “unfair” scrutiny from Income Tax department since last year overvaluations at which capital was raised from angel investors.
Department of Industrial Policy and Promotion has announced “waiver conditions” for so-called “Angel tax”. The notification1 says start-ups may avail of the tax concession only if total investment, including funding from angel investors (those who make the initial equity investment) does not exceed Rs.100 million. The details of which is outlined below in the article.
What is Angel Tax?
- What is Angel Tax?
- DIPP’s move- blossom for startups which are born after April, 2016
- Who will be qualify as a “Startup”?
- Who can avail tax exemption under clause (viib) of sub-section (2) of section 56 of the Act
- Tax benefit under Section 80- IAC of the Income Tax Act, 1962 (the act)
Former Finance Minister Pranab Mukherjee first introduced ‘Angel Tax’ under the Finance Act 2012. Simply put, the angel tax is a tax levied on investments made by external investors in startups or companies. Angel tax is applicable on the capital raised by unlisted companies from individuals against an issue of shares in excess of the fair market value. Such income has been classified as ‘income from other sources’ under Section 56 (viib) of the Income Tax Act. For example, if a startup whose shares are valued at INR. 100 and receives INR 150 from investors for the same then INR 50 will be subject to angel tax at the rate of 30.9%. This targeted at tackling laundering of money through high premium on shares. This route has earned a bad name as it has been misused for conversion of black money into white.
In 2012, the tax was 30.9% to mature private companies as well as small startups raising early-stage investments from Indian residents.
In 2016, the Central Board of Direct Taxes (CBDT) issued circulars2 to exempt eligible startups from angel taxes, even if the funding raised by a startup was in excess of fair market value. But this was not as lucrative as it seemed to be. Whether a startup is innovative or not, currently depends on a certification by the Department of Industrial Policy and Promotion (DIPP). This has led to several companies not being incubated inside government registered incubators or eligible for government grants. To be recognized as startup, as per government norms, it must not be older than seven years and must have an annual turnover that does not exceed INR 25 Crore. Most of the startups still had to pay angel taxes as most were not officially recognised as startups.
DIPP’s move- blossom for startups which are born after April, 2016
Department of Industrial Policy and Promotion vide notification G.S.R.364(E) dated 11th April, 2018 suppressing notification no. G.S.R. 501(E) has specified conditions for availing the “Angel tax” exemption on shares issued by start-ups over the fair market value. The notification has set out major relief to the start-ups following the stickling conditions to be recognised as “Start-up”. DIPP has also constituted a broad-based inter-ministerial board to look into the applications for claiming the tax exemptions.
Who will be qualify as a “Startup”?
An entity shall be considered as a Startup:
i. if it is incorporated as a-
a. private limited company (as defined under Companies Act, 2013);
b. registered as a partnership firm (registered under section 59 of the Partnership Act, 1932);
c. incorporated as Limited Liability Partnership (under the Limited Liability Partnership Act, 2008);
ii. seven years has not elapsed since the date of its incorporation or registration (in case of biotechnology sector, the period shall be up to ten years from the date of incorporation/ registration);
iii. turnover of the entity for any financial year since incorporation/ registration has not exceeded INR 25 crores;
iv. entity is working towards innovation, development or improvement of products or
processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
Provided that an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.
An entity shall cease to be a Startup on completion of seven years from the date of its incorporation/ registration or ten years, as the case may be, or if its turnover for any previous year exceeds Rupees 25 crore.
Who can avail tax exemption under clause (viib) of sub-section (2) of section 56 of the Act
“A Startup” can apply in FORM 2 along with requisite documents to avail tax exemption if the following conditions are fulfilled:
I. the aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed ten crore rupees,
II. the investor/ proposed investor, who proposed to subscribe to the issue of shares of the startup (hereinafter in this notification referred to as “investor”) has, —
a. the average returned income of twenty-five lakh rupees or more for the preceding three financial years; or
b. the net worth of two crore rupees or more as on the last date of the preceding financial year, and
c. the 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.
Tax benefit under Section 80- IAC of the Income Tax Act, 1962 (the act)
A Private Limited Company or Limited Liability Partnership incorporated on or after 1st day of April 2016 but before 1st day of April 2021 can apply to the Board in FORM 1 to avail certificate for claiming 100 per cent tax exemption under Section 80- IAC of the act on profits for any three consecutive years out of the initial 7 years of the start-up.
The conditions specified in the notification increased the compliance burden on the start-ups as such they will have to file forms for claiming profit linked tax benefits and angel exemption in addition to registration with DIPP. Further, as the approval from Inter-Ministerial Board would specify details of proposed investors, every funding from a new investor would require fresh approvals from the Board. This will benefit only those investors who have funded startups that have been certified by the government’s inter-ministerial board (IMB) will be eligible for the exemption. This would mean the majority of such investments get no relief. those incorporated before April 1, 2016, are not eligible for such breaks and will therefore also not be eligible for exemption from the angel tax. The criteria they plan to set for clearance by the IMB for exemption from Section 56 is supposed to be more relaxed. If the criteria doesn’t change, the dream will not become a reality. The positive is that the government is working to help address the issue. The need of the hour is to make it less, not more, onerous and bureaucratic.
(Author is associated with Mamta Binani and Associates and can be reached at firstname.lastname@example.org )