A Startup-Unfriendly Budget?

20th Mar 2012
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Section 56(2) provides for the specific category of incomes that shall be chargeable to income-tax under the head “Income from other sources”.It is proposed to insert a new clause in section 56(2). The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income tax under the head “Income from other sources.” However, this provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.

Further, it is also proposed to provide the company an opportunity to substantiate its claim regarding the fair market value.

Accordingly, it is proposed that the fair market value of the shares shall be the higher of the value—

(i) as may be determined in accordance with the method as may be prescribed; or

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any

other business or commercial rights of similar nature.

This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.

(Read here, pp. 8, 9)

Strange are the ways of taxing. The legalese behind the proposed amendment to Section 56(2) of the Income Tax Act is purported to point to the angel investor residing in India. Put simply, if a startup receives investment from an angel investor in India in lieu of shares (which are normally priced at premium over their face value), it will not be counted as an investment but income from other sources. And the standard taxation (generally to the tune of 30%) will apply to such investments.

The implications of this move are not clearly visible but as Budget discussions take place, the move may be rescinded. And if it happens, it will be good for the startup ecosystem. The question is who will represent this to the Hon’ble Finance Minister? Clearly, this amendment makes the Union Budget 2012 the startup-unfriendly budget. But startups have been also given ecosystem support in the form of a SIDBI’s India Opportunities Fund of Rs. 5000 crores. The Budget also has tax reliefs for venture capitalists. The clear slant towards favoring venture capital in the Budget is a welcome move but to tax the startups raising angel investment (considering such investment as income from other sources) is a bit baffling.

While the Government might have valid reasons for this amendment to stem spurious angel investments, this will definitely have an impact on early-stage funding in India, which is beginning to see entrepreneurial activity to a greater extent.

While we at YourStory carry this debate on the implications, we welcome views from entrepreneurs, angel investors and interested stakeholders so that we build enough momentum worthy of notice by the Government.

Venkatesh Krishnamoorthy, chief evangelist

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