The coming budget should lay-off the ‘angel-tax’, one of the biggest concerns for startups who raise funding and do not fall under the category ‘innovative’ as decided by the central government.
What is ‘Angel-tax’?
Angel tax was launched in 2012. When a closely-held private company receives equity funds from outsiders at a premium to the fair price, tax laws held the amount raised in excess to the fair price as taxable. The amount is reckoned as ‘income from other sources’ and taxed under Section 56 (ii) of the Income Tax Act.
The tax was a hefty one- at 30.9 percent and applied even to small startups that secured funding from residents of India. However, funds sourced from non-residents and VC funds were exempted from this tax.
Since startups have few mainstreaming funding resources and wanted the tax to be removed, the Centre exempted ‘innovative’ startups from Angel tax in 2016, on the investments made by Indian residents.
What is an ‘innovative’ startup?
Angel Tax hence created a confusion because it valued startups based on their assets alone. On the one hand, where government was supporting entrepreneurship through campaigns like Startup India, Angel Tax did no help to the startups.
In order to certify as an ‘innovative’ startup, it has to qualify following measures:
- Criteria of age: Not more than five years old
- Turnover: Not exceeding Rs 25 crore
- Purpose: Build new products or services
- Method: Technological or intellectual property
This valuation criteria only looks at certain parameters which may vary as per the domain of the startup. It was hence very difficult to arrive at a ‘fair value’ for them, based on discounted cash flows. The valuation which seems sky-high to some, may be fair to others.
Why get rid of ‘Angel tax’?
Angel Tax treats investment in unlisted companies at a share price which is above its market value as a money laundering exercise and taxes the premium amount at 30.9%. Removing this practice will provide relief to startups who are facing tax demands for funds raised prior to June 2016, alleging excessive evaluation.
As already discussed, deciding a ‘fair price’ for a startup can not be done because there barely are any revenues or profits that they generate at an early stage. The tax questions the governments goal of nurturing startups’ promotion.
Now in 2018, the scenario has very much changed. The income tax PAN(permanent account number) and Aadhar help keep a check on practices like money laundering and tax evasions. The government no longer has difficulty on tracking down fraudulent shell companies and penalizing promoters, however, hardcore entrepreneurs still suffers who issue the shares at the best price they can, to boost their capital base.