The government of India introduced the Angel Tax in 2012, with the aim to curb money laundering and tax evasion. However, in recent years, this tax has become a major concern for Indian startups and angel investors. It has drawn widespread criticism and raised questions about its impact on the country’s startup ecosystem. In this article, we will explore how Angel Tax is affecting Indian startups and investors, and the potential solutions to this issue.

What is Angel Tax?

Angel Tax, officially known as Section 56(2)(viib) of the Income Tax Act, is a 30% tax levied on the funding received by unlisted companies from an Indian resident angel investor. This tax is applicable to the amount of funding raised by startups that exceeds the fair market value of their shares.

The intention behind this tax was to prevent money laundering by shell companies that use the garb of angel investment to convert black money into white. The tax was also introduced to keep a check on the unaccounted money being invested in startups. But unfortunately, this has resulted in an added burden for legitimate startups that are trying to raise funds for their businesses.

Impact on Startups:

One of the biggest challenges faced by startups is raising capital. Angel investors play a crucial role in funding these startups, especially in their early stages. However, the Angel Tax has made it difficult for startups to secure funds as investors are hesitant to invest due to the additional tax burden. This has resulted in a slowdown in investment and growth for these startups.

The calculation of the fair market value of shares is another issue faced by startups. The tax authorities often use outdated and arbitrary methods to determine the value, which results in an inflated valuation of the company and, therefore, higher taxes. This unfairly penalizes startups, which are typically valued at a premium due to their potential for future success.

Moreover, startups have to go through a lengthy and complicated process to prove the genuineness of the funding received, which can take months or even years. This not only causes delays in fundraising but also creates a negative image for the startup in the eyes of potential investors.

Impact on Investors:

Angel investors are individuals who invest their personal funds in startups in exchange for equity. These investors take a high-risk bet on these startups and help them grow. However, with the introduction of Angel Tax, their investments are now subject to a hefty tax, which significantly reduces their returns. This has made investing in startups a less attractive option for angel investors, who are now looking at alternative investment opportunities.

In addition, due to the vague calculation of fair market value by tax authorities, investors are at risk of facing undue scrutiny and demands for additional tax payments. This creates uncertainty and discourages them from investing in startups, ultimately hindering the growth of the startup ecosystem in India.

Solutions:

To address the concerns of startups and investors, the government of India has introduced some measures. In 2019, it raised the exemption limit for startups to Rs. 25 crores from Rs. 10 crores in the total valuation of the company under the Startup India program. This move provided some relief to startups but did not completely solve the problem.

Another solution proposed is the introduction of a safe harbor rule, where startups will be exempt from Angel Tax if they meet certain conditions. This will reduce the burden on startups to prove the legitimacy of funds received and also provide clarity on the fair market value calculation.

Conclusion:

The intention behind the Angel Tax was to curb illegitimate activities but has resulted in unintended consequences for the Indian startup ecosystem. It has become a roadblock for startups and investors, hindering the growth of innovative ideas and businesses in the country. The government needs to carefully assess and revise the policies to create a more conducive environment for startups and investors while also addressing the concerns of tax evasion.

India has been striving to create a more welcoming environment for startups, and the Angel Tax issue is a major obstacle to this goal. The government needs to strike a balance between preventing tax evasion and promoting a vibrant startup ecosystem. We hope that with the implementation of fair and practical solutions, the impact of Angel Tax will be minimized, and India can continue its journey towards becoming a hub for innovation and entrepreneurship.