Angel tax: the latest DIPP notification demystified for startups, investors

As the startup ecosystem digests the government’s latest notification regarding the angel tax, here is a closer look at the fine print.

Amid several calls from startups for abolishing angel tax and media reports that the government may water down angel tax provisions, on January 16, 2019, the government notified the much-needed amendments, allowing startups recognised under the Startup India initiative to seek approval and claim relief.

Here are some of the key amendments in the notification:

• The requirement of ‘Merchant Banker Valuation’ has been done away with for recognised startups.
• For claiming exemption u/s 56 (2) (viib), (the underlying section of the Income Tax Act which triggers the ‘Angel Tax’), the approval from Inter-Ministerial Board is no longer required.
• Instead, the Department of Industrial Policy and Promotion (DIPP) shall send the applications seeking exemptions to the Central Board of Direct Taxes (CBDT) for its approval. This approval from CBDT shall be provided or rejected within 45 days from the receipt of application from DIPP.
• The application for approval shall be made in Form-2 to DIPP along with the specified documents therein.
• The application can be made by a recognised startup, either for shares already issued or for a proposed investment.

The conditions for the application for approval and claiming the exemption are as follows:

1. The startup should be recognised by DIPP, by way of an online application under the Startup India initiative (this is a general recognition; for claiming exemption from angel tax, additional approval from CBDT as per this notification is required).
2. The aggregate amount of paid-up capital and share premium of the startup after the proposed issue should not exceed Rs 10 crore.
3. The investor/proposed investor should have returned income of Rs 50 lakh or more for the financial year preceding the year of investment/proposed investment, and a net worth exceeding Rs 2 crore or the amount of investment proposed, whichever is higher.

So, what do these amendments mean for startups, and what is their impact on angel tax?

Of late, the general recognition and registration of startups under the Startup India initiative has picked up pace, and a lot of startups have already got the initial recognition under the programme. However, for availing income-tax exemptions and exemption from angel tax, they earlier needed approval from Inter-Ministerial Board (IMB). This was turning out to be a bottleneck and a time-consuming process, as not many startups were able to pass the test from the IMB. Also, as the approval was not time-bound, the process of acceptance/rejection was often delayed.

The new move removes the requirement of approval from IMB and replaces it with approval from CBDT in a time-bound period of 45 days. This will quicken the whole approval process for the startups.

Further, approved startups were earlier required to obtain valuation from a merchant banker to substantiate the value of shares/premium. This requirement too has been done away with for approved startups.

Challenges involved

This notification shows the government’s intent to clear the haze around angel tax and bring down the litigation in this matter. It should increase the number of approved startups that can avail the exemption. However, the picture is not all that rosy. There are still quite a few grey areas and practical difficulties that will have to be analysed. For instance:

• The wordings of the notification do suggest that the approvals will have to be obtained for each past or prospective investment individually. It is therefore not a blanket exemption for the startup or the investor. A fresh application will have to be made for every investment round to get the approval for that round of investment to be out of the ambit of angel tax. This is an additional compliance burden involving additional time and cost associated with each angel round of investment. 
• The application and approval process may take up to 45 days, and if the application is rejected, the chances of the Tax Officer citing the rejection and raising demands under the angel tax provisions increase manifold as compared to how it is at present. This may force the startups to wait for the approval, before proceeding with the investment round.
• The requirement of an investor having a returned income of at least Rs 50 lakh or a net worth of at least Rs 2 crore may, in many cases, be too big an ask for the friends-and-family round of angel investment and for small-budget investors.
• Also, many angel investors will not be willing to disclose their returned income and net worth, citing personal and privacy concerns, even though the requirement has been put on the investors to submit these details directly to the DIPP.
• Even though the requirement of obtaining a valuation report from a merchant banker is done away with, the approval application in Form-2 requires, “justification of valuation of shares along with supporting documents, if any”. This will again need supporting documents and explanations on projections/workings or a valuation report to substantiate the claim of higher valuation. Also, this requirement being open-ended and vague may lead to more litigation and rejection of approval applications by CBDT.
• It’s also important to note that the notification clearly says that in case the application is made for an investment received earlier, (i.e. before this notification) the exemption shall be available only in case the assessment order has not been passed by the tax officer. Which means that this notification will not be of any help or relief for older cases where demands have already been raised against angel tax provision.

The way forward

Even though the intent seems to be good, the process involved is still cumbersome and time-consuming. Additionally, it remains to be seen how things are handled on the ground by both DIPP and tax officials at CBDT. If the practical difficulties are taken care of, this can truly be considered a good step forward.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)