Overview of Angel Tax: Explaining the Controversial Tax on Startup Funding

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Angel Tax, also known as the “Anti-Abuse Regulation” or “Section 56(2)(viib) of the Indian Income Tax Act”, has been a highly controversial topic in the world of startup funding for the past few years. This tax, which was introduced in 2012 to curb money laundering and illegal activities, has caused distress and outcry among the Indian startup community. In this article, we will provide an overview of Angel Tax, its impact on startups, and the ongoing debate surrounding it.

Firstly, let us understand what Angel Tax is. In simple terms, Angel Tax is a tax that is levied on the excess capital raised by unlisted companies, specifically startups, from an angel investor or a high net worth individual (HNI). As per the regulations, any investment received by a startup that exceeds the “fair market value” of its shares will be treated as income of the startup and taxed accordingly. This means that a startup is liable to pay a tax of 30% on the difference between the amount raised and the fair market value.

The intent behind Angel Tax was to prevent the misuse of funds by startups and to discourage cash transactions in the investment process. However, the implementation of this tax has caused a significant roadblock for startups, especially in the early stages of their growth. This is because most startups, in their initial phase, rely heavily on angel investments to finance their business. With the imposition of Angel Tax, many startups have found it difficult to raise funding and have been burdened with hefty tax bills that they are unable to pay.

One of the major issues with Angel Tax is the ambiguity surrounding the calculation of the fair market value of a startup. There is no clear methodology outlined by the government for determining this value, leading to differing opinions among tax officials and startups. This has caused confusion and uncertainty, making it difficult for startups to comply with the regulations. Moreover, since startups are not yet profitable, this tax has been seen as a punitive measure that hinders their growth rather than promoting it.

The impact of Angel Tax has not gone unnoticed, and it has sparked a heated debate between the government and the startup community. Startups have been vocal about the adverse effects of this tax, citing the high compliance costs, lengthy procedures, and the negative impact on their cash flow. Many have argued that Angel Tax is a disincentive for investors and is hindering the growth of the startup ecosystem in India.

In response to these concerns, the government has made certain amendments to the regulations in recent years. In 2019, the Department for Promotion of Industry and Internal Trade (DPIIT) introduced a relaxation for startups registered under the Startup India program. These startups can now avail an exemption from Angel Tax if they fulfill certain conditions. Additionally, the Central Board of Direct Taxes (CBDT) has also increased the threshold for startups to be eligible for this exemption from Rs. 10 crore to Rs. 25 crore.

While these efforts by the government have been welcomed by the startup community, they have been deemed inadequate to address the larger issue at hand. The definition of a startup and the eligibility criteria for the exemption have been criticized for being too restrictive, leaving out many deserving startups. There have also been demands to completely scrap Angel Tax and provide a more conducive environment for startups to thrive.

In conclusion, Angel Tax has been a sore spot in the Indian startup ecosystem, causing significant concerns among startups and investors alike. While the intention behind this tax was to prevent illegal activities, its implementation has caused harm to the very startups it was trying to protect. The ongoing debate on this issue highlights the need for a comprehensive and well-thought-out policy that promotes and supports the growth of startups, rather than hindering it. It is time for the government to address the concerns of the startup community and take necessary steps to make the investment process smoother and more encouraging for startups.