India is the third largest startup ecosystem in the world. But legal and tax issues have at times remained ambiguous, swaying through time. A doubt that Indian entrepreneurs often ending up spending hours over research is the angel tax.

What is Angel tax?

By definition it is the tax payable on capital raised by unlisted companies via issue of shares where share price is seen in excess of fair market value of shares sold. The excess realisation is treated as income by the income tax department and is taxed accordingly. It was first introduced by Pranab Mukherjee (Finance Minister back then) during the 2012 budget. It was taken as a precautionary step to stop laundering of funds. Over the years it earned the nickname of angel tax, owing to the fact that it mostly affected angel investments in startups

Where is the issue?

There are mainly two ways to ascertain the Fair Market Value (FMV) of a company

1. Discounted Cash Flow (DCF)
2. Net Asset Value (NAV)

The  Section 56(2)(viib) of the Income Tax Act, 1961 (popularly known as angel tax) states the FMV may be decided by one of the aforementioned methods or as substantiated by the company to the satisfaction of the Assessing Officer (AO).

This places way too much power in the hands of the AO and startups have suffered from the same.

The fallacies in prediction

The DCF method relies on the prepared business plan to calculate the present value of future cash flows. It is subject to risks and changing market conditions. The startup is again penalised when the calculations go wrong. Aside from monetary fines, the startup founders often lose peace of mind over the same.

Remedies

A major issue is the lack of guidance for entrepreneurs in financial matters. Incubators and accelerators are increasing in number in India and have been successful in curbing the issue to a large extent. JCurve, a Chandigarh based incubator provides financial guidance , tech expertise and even seed investment to help new ventures build their business.

Govt too has stepped forward,  over the years softening the blows from the dreaded angel xax.  In 2016 CBDT released notification stating that for any company registered as a startup and recognised by the Department of Industrial Policy and Planning(DIPP), any amount raised from an Indian tax resident will be outside the scope of the angel tax. The exemptions for the above mentioned notification are:

1. Any funds received from a Venture capital fund or Venture Capital company
2. Non residents

In April 2018, the govt introduced further exemptions from the tax. Startups were exempted from the tax when the total funding received from angel investors did not exceed 10 crore. Startups are required to get approval from inter ministerial board and a certificate of valuation by a merchant banker for the same . The exemption will only be granted in cases where angel investor had a minimum net worth of 2 crore or an average returned income of over 25 lakh rupees in the preceding 3 financial years.

Again this year (2019) Govt took another step and relaxed norms for companies that can be termed as startups. Now an entity can be considered as a startup upto 10 years after its incorporation. This is in contrast to the 7 year years as stated by law before. In turnover too, the upper limit for tax exempt startups has been raised from Rs 25 crore to Rs 100 crore.

Conclusion

Indian startups received a staggering USD 10 billion worth of investment last year. However the contribution of domestic investors was merely 10%. The new changes in law will definitely beckon more investors forward and Indian startups  can expect a rise in investments. Further govt policies encouraging investments rather than penalising them can accelerate the success of Indian startup economy.