The impact angel tax has brought to startups in India

For a while, angel tax in India has remained a controversial issue. It was first introduced in India under Section 56(2)(viib) of the Income Tax Act, 1961 and was aimed to be an anti-abuse measure to prevent money laundering and routing of black money through the guise of startups.

Since then, startups and investors allege that the provisions of tax are vague, unclear, and arbitrary, leading to unwarranted harassment by tax authorities. In many cases, start-ups have faced notices and demands for payment of angel tax, even when the investments were made at fair market value and in accordance with all applicable laws.

The Indian government took cognizance of this issue and introduced several measures to address the issue. In February 2019, the government issued a notification exempting startups from angel tax, subject to certain conditions.

These conditions for exemption from angel tax include that the startup should be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) and approved by the Inter-Ministerial Board (IMB), the investment should be made by an angel investor registered with the Securities and Exchange Board of India (SEBI), and the investment should not exceed the fair market value of the shares issued by the startup.

With the Budget of 2023, the earlier distinction allowing foreign investors an exemption from the provisions of angel tax has now been done away with, which has made for a level playing field for domestic investors, but has alarmed startups, as they fear an upcoming dearth of foreign funding as a result.

As such, the DPIIT too specifies certain criteria for registration as a startup. It must be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership, the issued and paid-up capital of the startup must be within 25 crores and its turnover should be less than Rs 100 crore in any of the previous fiscal years.

Qualifications also include that the company must not be a company formed simply as a result of the splitting up or reconstruction of an existing business, or simply by the transfer of assets to a new business. It also says that a business can only be referred to as a startup for the first 10 years of its operations.

In case the company meets the above criteria, it shall be eligible to take a tax exemption from angel tax, subject to the approval of the IMB.

As per law, section 80 IAC of the Income Tax Act, 1961 allows startups to take 3 consecutive years of tax holiday, if it has not, in 7 years since the issue of shares at a premium invested in, the use of a building or land for a purpose (other than personal use or for stock in trade or as rental property).

It also permits to advance loans (other than when the lending of money constitutes the bulk of the business of a startup) besides contribution of capital to another entity via stock or bonds, shares and securities, motor Vehicle, aircraft, yacht, or any other mode of transport, the actual cost of which exceeds Rs 10 Lakhs (other than that held by the startup for the purpose of plying, hiring, leasing, or as stock-in-trade, in the ordinary course of business), jewelry (other than that held by the startup as stock in the ordinary course of business) and of goods like archaeological collections and artifacts.

Investments, both domestic and foreign have been critical to India’s economic growth and overall development. The Government’s attempt to provide for exemptions has eased the burden of startups and investors, providing a sigh of relief.