Why the government's latest move is a 'surgical strike' against Angel Tax

We take a look at what the Commerce Ministry's approval of the guidelines around one aspect of the controversial Angel Tax means for India's startup ecosystem.

Earlier today, Union Minister Suresh Prabhu tweeted that he was delighted to say that a Gazette Notification would be issued, "simplifying the process for startups to get exemptions on investments under Section 56(2)(viib) of Income Tax Act, 1961". Details of the proposal were available on the PIB's news releases page online. As news spread, the startup ecosystem breathed a sign of relief.

The notification does not address Section 68 of the same Act, under which startups have received notices asking them to provide the Income-Tax Returns and bank statements/books of accounts of their investors to trace the funds received.

Earlier this evening, the Department for Promotion of Industry and Internal Trade (DPIIT) issued an extraordinary gazette notification to this effect. Stakeholders that YourStory spoke to said the Central Board of Direct Taxes, which oversees the Income Tax Department, is expected to issue its own circular in sync with what the proposal has outlined.

YourStory had earlier reported that the government was expected to announce wide-ranging

exemptions. The proposal enables two major changes which together will help the startup ecosystem in a big way.

Also read: Angel Tax: Government finally provides a breather

The good news...

For one, it allows companies up to 10 years old to be classified as startups instead of the earlier seven years. This means a greater number of companies are eligible for benefits available to startups, and for a longer time.

Next, the upper limit for annual revenue to be classified as a startup was raised to Rs 100 crore from Rs 25 crore earlier, which also widens the base of startups eligible for tax and other benefits under the Startup India programme.

But the big bang statement, says Siddarth Pai, Co-founder of 3one4 Capital, was the line that said, "Consideration received by eligible Start-ups for shares issued or proposed to be issued shall be exempt up to an aggregate limit of Rs 25 crore." Now this means that the provisions of the circular can be applied even retrospectively. Earlier circulars and guidelines have all been prospective. He believes,

"The ramifications of this are tremendous...any startup that has already faced the issue (i.e. received a notice) and is going through the appeals process, can take recourse under this circular, register with the DPIIT (if not already registered), cite the circular along with the one that the CBDT is likely to issue, and present it as evidence during the appeals process."

This way, he adds, the Assessing Officer would need to take it under consideration. However, not everyone is convinced of this.

The grey areas...

Angel investor Rehan Yar Khan, Managing Partner at Orios Venture Partners, tweeted that the announcement fell short of expectations. He too believes that startups who have received notices from Assessment Officers have been denied relief.

Entrepreneur and investor Rajesh Sawhney, Co-founder of InnerChef, told YourStory,

"I welcome the move, but we need to make sure that the notices sent to startups are withdrawn with immediate effect."

V Balakrishnan, Founder and Chairman, Exfinity Ventures, shares a similar opinion: "It is a good step forward as it covers most of the issues but the challenge remains on the implementation side. The I-T authorities, the way they implement, will be very important. For example, if one looks at the issue to TravelKhana, it started with Angel Tax issue and ended up with Section 68."

Tweets from the DPIIT's Twitter handle, put out during the course of a press conference held in New Delhi, also did not clarify the point of whether or not the provisions would help out startups that have already received notices.

Opening up domestic capital for startups

As reported earlier by YourStory, the new notification also allows listed companies with a net worth of Rs 100 crore or turnover of Rs 250 crore to invest in eligible startups, with such exemptions also being exempt under Section 56 (2) (viib) of Income Tax Act up to Rs 25 crore. This opens the doors for a massive pool of domestic capital to be poured into the Indian startup ecosystem.

As Siddarth explains, "For a startup ecosystem to thrive anywhere, you need active participation from listed entities. In the US, Google, Amazon, Facebook, all invest heavily in startups. And while the entire world is coming to India, Indian listed companies are looking abroad for startups."

With their investments now being made exempt, this should now change, he added. Industry body iSPIRT echoed this sentiment in its blog earlier today,

"At long last, domestic pools of capital will no longer be disadvantaged as compared to foreign sources. At long last, Indian entrepreneurs will no longer have to fear the questioning of the valuations of their businesses and taxation of capital raised."

Industry reactions to the announcement have largely been positive.

Prashant Pansare, Co-founder of Eagle10 Ventures and an entrepreneur himself said, "The announcement brings ... relief for angel investors and early-stage startups alike. It is a very welcome step that will encourage more people to invest in early-stage, which was up in the air so far."

Padmaja Ruparel, Co-Founder, Indian Angel Network (IAN) and Founding Partner, IAN Fund, called it a 'seminal move for angel investing and the foundation of Startup 2.0'.

"A big thank you to the PMO’s vision, and to DIPP and CBDT for finding an innovative solution to the Angel Tax,” she said in a statement.

The first big step on a long road?

When the last circular came out, Pavan Sharma, a partner at BCL India, an accounting firm, told YourStory. “What we needed was major surgery but what's been offered is a cosmetic change.” We asked Siddarth Pai how he would describe the latest notification. His prompt response? "This almost seems like a surgical strike!"

Overall, we believe that today's notification is the first step on the road to putting an end to the menace of Angel Tax. We welcome the move but we look forward to clarifications from the DPIIT and the CBDT with respect to those startups who have received notices from the I-T Department and what can be done to end the hassles they are facing without further delay.

With inputs from Thimmaya Poojary, Sindhu Kashyap, and Sameer Ranjan.

Disclaimer: 3one4 Capital is an investor in YourStory.