Revised Angel Tax norms give major relief to startups
The latest notification has widened the definition of startups, increased the investment limit to Rs 25 crore to avail tax benefits, and also aims to keep a check on diversion of funds and generation of black money.
The Department for Promotion of Industry and Internal Trade (DPIIT), earlier known as Department for Industrial Policy and Promotion (DIPP), under the Ministry of Commerce, issued a notification on Tuesday that will provide major relief to startups from Angel Tax.
While the notification reclassified the definition of startups, it also offered clarity on tax exemptions.
Here is a look at some of the major changes made in the latest notification.
Expanding the definition of startup
1. An entity (private limited company, LLP, or a registered partnership firm) shall now be considered a startup for up to a period of 10 years from the date of incorporation/ registration. Earlier, it was just seven years. The 10-year benefit was earlier available to startups only in the biotechnology sector.
2. The turnover limit has been increased from the existing Rs 25 crore to Rs 100 crore.
Relaxed conditions for claiming exemption from Section 56 (2) (viib)
1. The limit of aggregate amount of share capital and share premium of the startup after issue or proposed issue of shares has been increased to Rs 25 crore from the existing Rs 10 crore
2. Not only has the limit been increased, the limit does not include investments received from:
a. A non-resident
b. A Venture Capital Fund or a Venture Capital Company
c. Specified company (listed companies whose shares are frequently traded and who have a net-worth exceeding Rs 100 crore or turnover exceeds Rs 250 crore)
This means, startups can now receive Angel Funds from domestic Indian Angel Investors to the tune of Rs 25 crore (excluding investments from NRs, VCs and listed companies), without worrying about the implications of Angel Tax, which is a big boost to the startup ecosystem.
3. The earlier requirement of approval from Inter-Ministerial Board (as per the April 11, 2018 notification), and then from the CBDT in a time bound 45 days (as per the relaxed notification on January 16, 2019), has now been replaced with a simple declaration in Form 2.
4. The Long Form 2 issued with the previous notification and the requirement of substantiating the higher valuation with supporting documents and explanations have also been done away with.
Now, eligible startups neither require a merchant banker valuation report, nor are they required to substantiate the higher valuation with explanations and supporting details and documents. This is also a big relief.
5. All the benefits shall continue to be available only for startups getting recognition as a ‘Startup’ through online application over the mobile app or portal set up by the DPIIT.
Additional restrictions on use of funds from investment in following asset class to be declared in Form 2
The latest notification has come up with a new list of restrictive asset class in which startups cannot invest during the time of raising an investment (by way of issue of shares at a premium), and up to a period of seven years from the end of the financial year in which shares are issued at premium, and a declaration in this regard must be given in Form 2 for claiming the exemptions, which the DPIIT shall forward to CBDT and the Income Tax Department.
1. Residential land and building (except when held for renting or re-sale in ordinary course of business of the startup)
2. Non-residential land and building or both (except when occupied for its business or held for renting/re-sale in ordinary course of business)
3. Loans and advances (except if the startup is in the lending business)
4. Capital investment in any other entity
5. For purchase/investment in shares and securities
6. A motor vehicle, aircraft, yacht or any other mode of transport for which the actual cost exceeds Rs 10 lakh (except if held for trade or plying, hiring, leasing)
7. Jewellery (other then trading in ordinary course of business)
8. Other purchases like (a) Archaeological collections (b) Drawings (c) Paintings (d) Sculptures or any work of art; or (e) Bullion (except in the ordinary course of business in these items)
These conditions are carefully drafted with an intention to keep a check on diversion of investment funds and generation of black money. Ideally, a genuine startup will not make investments in these luxury items, especially from an investor’s funds.
What does this mean for startups, and its impact on Angel Tax
a. 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 initial recognition under the programme. With the requirement of approval from the inter-ministerial board (IMB) and CBDT replaced by a simple declaration from the startups, a huge boost is expected.
b. The expansion of definition of startups to cover companies incorporated for up to 10 years and having up to Rs 100 crore turnover will bring many startups under the ambit of this exemption
c. The removal of requirement of valuation report or documents/explanations/workings supporting higher valuation and share premium will also make things a lot easier for startups
d. The increase in share capital/share premium limit to Rs 25 crore from the existing Rs 10 crore and excluding investments from non-residents, VCs and specified listed companies has also expanded the reach of the benefit to many startups who were earlier forced out of the ambit of this benefit.
The latest notification has addressed most of the concerns raised earlier and has made the base scope of exemption very wide. It has also made the system and process very simple and transparent with not much complications. However, the following challenges remain.
I. The restrictive asset class includes capital contribution in other entities and investment in shares and securities. Disbursement of loans and advance to other entities are also restricted. This means receiving investment in one entity and using it to fund some other group entity or holding/subsidiary entity will not be allowed from the Angel Investment Funds. It means startups will have to be careful to take investments directly in the recognised entity and use it fully in the same entity, else they will not be able to claim the benefits. This step was important from the government’s side to keep a check on diversion of funds and generation of black money through complex entity structures, which was rampant in the past.
II. The notification does not cater to the entities where assessment orders have already been passed and demand raised on account of Angel Tax. For such companies taking instant startup India recognition and defending the case at the appellate stage (with CIT (A) or ITAT) is the only option. However, this notification will help them in the appeals stage as this shows the intent of the government, which is not to punish genuine startups. We have heard about commitments from the Income Tax Department about quick disposal of appeals, and also that the demand recovery process shall not be stringent in case of Angel Tax demands. However, ground reality in the light of the new notification is yet to be seen.
III. A notification from CBDT and the Income Tax department is also expected to make necessary changes in the Income Tax laws to give credible effect to this notification. The fine prints of the CBDT notification has still to be seen and analysed.
This is a welcome step by the government, and it takes care of a large chunk of issues raised by the media, experts and the startup ecosystem on Angel Tax. The restriction on investments in certain asset class will also ensure the exemption is not misused to a large scale.
Now, it’s time for startups to get themselves recognised with the DPIIT as a startup, if not already done and start filing declarations in Form 2 to save themselves from Income Tax notices and Angel Tax.
For those who have already received the demands and assessment orders making additions on account of angel tax, fighting it out at appeal stage and getting the case disposed at the appellate level is the only way forward.
For ongoing assessment cases, the Income Tax rules and processes will have to be followed to get the assessments closed, and this notification will be helpful in getting a favourable order.