While venture capital firms are exempted from this tax, only individual investors are targeted.

Angel investors in startups worried over angel tax seek relief from govt
Atom News Wednesday, December 27, 2017 - 23:21

With the next Union Budget just a few months away, different sectors in the economy are trying to draw the attention of the Finance Ministry seeking favourable changes in the taxes and concessions affecting their sector.

The latest to raise their concerns are the angel investors whose investments in unlisted companies get taxed as ‘Angel Tax’ if the valuation of the startup or the company receiving the fund is above the ‘fair market value’ in the assessment of the Income Tax authorities.

There are a few contentious issues here. One important dichotomy in this is that the venture capital firms are exempted from this tax and only individual investors are targeted. The other major point of dispute is the computation of the ‘fair market value’. One must hasten to clarify that the government has already exempted innovative startups from the levy of ‘Angel Tax’ about a year and a half ago. But this again is not such a straightforward case since the startup will have to obtain a certification from the Department of Industrial Policy and Promotion that it is indeed an ‘innovative startup’. Everyone knows, how difficult it could be with the Indian bureaucracy to manage such things.

The relevant regulation says that under Section 56(2)(vii b) of the Income Tax Act, if a company receives any consideration from a resident for issue of shares exceeding the face value of such shares, then the aggregate consideration exceeding the fair market value of the shares will be taxed as ‘income from other sources’ and this excess value is then taxed at 30%.

Now, the immediate provocation for approaching the Finance Ministry is that this levy has resulted in a decline in the funds raised by the startups and the number of such angel funding rounds has seen a sharp decline from 291 in 2016 to 191 in the year 2017.

There are also other related issues; one is that the startups, which may be classified as being innovative also are being issued notices by the IT department in respect of the funds received by them before the exemption notification was issued in June 2016. This has been confirmed through a survey done with over 2000 startups in the country and almost a third of them confirmed that they have been issued notices by the income tax department.

But it may not be easy to have their way since there are a number of government departments and agencies involved in the process of initiating such an exemption or for scrapping the tax. These include CBDT, DIPP, SEBI and the finance ministry.

Even if some kind of mechanism is put in place to identify the genuine angel investors and bracket them with the venture capital firms, there will be complaints of arbitrariness and lack of transparency in the process.

The Finance Ministry is always called upon to do this tightrope walk during budget preparation of striking a balance between forfeiting revenue and supporting growth-oriented sectors of the economy.

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