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Angel Tax fiasco: Government To Soften The Blow On Startup Businesses

New Delhi, February 12: In terms of the number of businesses, India is the second biggest ecosystem for the start-up. Even though the incumbent government has time and again promoted the entrepreneurship in the country, from the past two weeks it is receiving constant flak from the startup ecosystem, as it is facing a new hurdle, that is, Angel Tax. This was prompted by the Income Tax Department seizing the accounts of two Indian start-ups- TravelKhana and Babygogo. Start-ups alleged that the government’s most-vaunted Startup initiative is affecting their financial health.

A large number of startups have received notices to pay angel tax. According to a survey conducted by LocalCircles and Indian Venture Capital Association, around 73% of startups said they have received at least one angel tax notice, while 30% have received three or more such notices most recently.

What is Angel Tax and why is it problematic? 

Angel investors are HNI or High-net-worth individuals who invest their personal money into the startup in the early stages when such entrepreneurial ventures find it difficult to access traditional sources of funds. They provide mentorship to startups. Here is how SEBI defines an angel investors, under the Alternative Investment Fund Regulations.  Any person who proposes to invest in an angel fund and satisfies one of the following conditions, namely,
(a) an individual investor who has net tangible assets of at least two crore rupees excluding the value of his principal residence, and who:

(i) has early stage investment experience; or
(ii) has experience as a serial entrepreneur; or
(iii) is a senior management professional with at least ten years of
experience

(b) a body corporate with a net worth of at least ten crore rupees; or
(c) an AIF registered under these regulations or a VCF registered under the SEBI (Venture Capital Funds) regulations, 1996.

Introduced by the UPA government in 2012, angel tax refers to a section of Income Tax Act that deals with taxing any capital raised by a closely-held company or startup which is above or excess of its Fair Market Value. This amount is deemed as income from other sources and is taxed at 30.9%. There, however, is no clear objective way to determine the Fair Market Value of the startup. Angel investors at the funding stage pay for the potential of an idea and the valuation is tied to the assessment of that potential. As per the Section, Fair Market Value is defined as the value-

a) as may be determined in accordance with such method as may be prescribed; or
b) 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;

According to a report by iSpirit, a think-tank of the Indian software industry, ideally a taxman or the Assessing Officer should not have the discretionary power to disregard a valuation acceptable to the startup and a group of sophisticated investors and arrived at by a professional in the form of a qualified Charted Accountant or a Category 1 Merchant Banker. Many startups have faced a challenge, whereby, the assessing officer takes the lower value as the Fair Market Value and taxes the entire premium as income in the hands of the companies. Additionally, the law states that the companies need to satisfy the assessing officer based on the value of the company, as on the date of the fundraising, whereas the valuation methodologies allow for you to discount future cash flows as of today. These contradict each other as the value as of today will always be less than the value in the future. This leads to taxation on the basis of the present Net Asset Value instead of the probable future value.

A big relief:

To soften the blow, according to a news report by the Economic Times, DIPP is believed to have accepted some of the demands by the startups, which it will notify by the end of this week. It is also planning to hike the investment limited for availing the income tax concessions by the startups. Adding to it, the government might increase investment limited for tax exemption from ten crores to twenty-five and forty crores. It is also likely to recognize all companies that are operational for up to ten years as startups.

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