Central idea: The article provides an overview of the angel tax provisions in the Finance Bill, which were introduced in the Budget. It highlights the concerns raised by the start-up community regarding the impact of these provisions on their operations.

What is Angel Tax?

• Referred to as Angel Tax, this rule is described in Section 56(2)(viib) of the Income Tax Act, 1961.
• Essentially it’s a tax on capital receipts, unique to India in the global context.
• This clause was inserted into the act in 2012 to prevent laundering of black money, round-tripping via investments with a large premium into unlisted companies.
• The tax covers investment in any private business entity, but only in 2016 was it applied to startups.

Why was angel tax introduced?

• The complicated nature of VC fundraising with offshore entities, multiple limited partners and blind pools is contentious.
• There has been some element of money laundering or round-tripping under guise.

Details of its levy

• The Angel Tax is being levied on startups at 9% on net investments in excess of the fair market value.
• For angel investors, the amount of investment that exceeds the fair market value can be claimed for a 100% tax exemption.
• However, the investor must have a net worth of ₹2 crores or an income of more than ₹25 Lakh in the past 3 fiscal years.

Startups under scrutiny

• As more and more new-age tech startups started raising VC funding, they came under the IT department scrutiny.
• These funding deals often saw investors paying a premium above the face value or the fair market value of securities, and therefore were taxed as income for the startup.
• Between 2016 and 2019, startups urged the government to add exceptions that would allow them to be exempt from the Angel Tax.

Which startups are exempted?

• There is a clear provision that says that start-ups which are recognized by DPIIT are out of the proposal’s purview.
• The start-up recognition process is also very simple where any applicant gets it automatically.
• However, the key condition for exemption is that the aggregate amount of paid up share capital and share premium of the startup after issue or proposed issue of share does not exceed INR 25 Cr.

Concerns raised by startup

• Compliance burden: Even beyond the issue of taxation, the compliance burden on startups will potentially increase significantly under the new rules.
• Persisting slowdown: The timing of this potential tax is most worrying since it coincides with the ongoing startup funding slowdown.
• Fear of off-shoring: Entrepreneurs and investors are concerned that applying strict taxes on capital receipts without adequate exceptions will lead to startups moving overseas.

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