Angel Tax has been a topic of significant debate in India, especially for startups looking to raise early-stage funding. This blog explores what Angel Tax is, its history, how it works, its implications, and the recent changes that make it more favourable for businesses in India.
Latest Update On Angel Tax
In the Union Budget 2024, Finance Minister Nirmala Sitharaman has proposed to abolish the Angel Tax with effect from FY 2025-26 to boost India’s startup ecosystem.
What Is Angel Tax?
To operate an early-stage venture, every business needs funds. In the same way, startups look for investment in exchange for equity because they don’t have enough tangible assets to offer as collateral. That’s where an angel investor comes in. An angel investor provides initial seed money for startup businesses, usually in exchange for ownership equity in the company.
Angel Tax is a tax levied on the premium amount received by unlisted companies when they issue shares to angel investors. This concept was introduced in 2012 under Section 56(2) (vii b) of the Income Tax Act. This tax comes into play if the total investment value exceeds the company’s FMV or Fair Market Value.
For example, if a company’s FMV is ₹1 crore and it raises ₹1.5 crore from angel investors, then the excess amount of ₹50 lakh is subject to this tax. Tax authorities consider the premium paid by investors as income and is taxable at around 31%.
Why Was Angel Tax Introduced?
Below are some of the reasons why the Angel Tax was introduced.
- Angel Tax was primarily introduced to prevent money laundering. By scrutinising and taxing the excess premium on share valuations, the government can reduce the chances of unaccounted money being funnelled through inflated investments.
- Angel Tax encourages fair and transparent valuation practices. It pushes companies to offer a more realistic valuation of their shares, which helps in maintaining market integrity and investor confidence.
- When the excess premium is taxed, the government earns additional revenue. This revenue can be used for several developmental activities and public welfare programs.
What Were The Challenges Faced By Startups Due To Angel Tax?
When the Angel Tax was introduced, startups faced many challenges, such as:
Unpredictability Of Valuation – Startups often have high valuations based on future potential rather than current financial performance. This has made it difficult for them to justify their valuations under traditional methods used by tax authorities.
Deterrence Of Investment – Angel investors became hesitant to invest due to the potential tax implications. Many investors began to shy away from early-stage ventures due to scrutiny from tax authorities.
Administrative Burden – Startups had to spend a considerable amount of time and resources to resolve tax disputes and comply with the legal requirements to prove the legitimacy of their valuations.
Lack Of Clarifications – The initial framework lacked clear guidelines on how valuations would be analysed. This led to arbitrary tax assessments by authorities.
Also Read: All You Need To Know About Saving Income Tax
The Current Union Budget Announcement For Angel Tax
As mentioned at the beginning of the article, the Union Budget 2024 proposed that the Angel Tax would be abolished. The amendments are said to take effect from the assessment year 2025-26.
How Will The Removal Of Angel Tax Help Startups?
The removal of the Angel Tax in India offers several benefits. We have mentioned a few of them below:
Increased Access To Funding – With the abolishing of the Angel Tax, startups can now raise capital more freely from both domestic and foreign investors without worrying about the tax and the premium of FMV. This will encourage a broader pool of investors, particularly from foreign venture capitalists, who were previously cautious because of the potential tax burden.
Simplified Valuation Process – Since tax authorities could challenge the FMV of shares, startups often faced scrutiny over their valuations under the Angel Tax regime. Now that the tax is abolished, startups have greater flexibility in negotiating values with investors, thus reducing the risk of disputes.
Boost To The Startup Ecosystem – The removal of this tax aligns with India’s goals to become a global startup hub. As of October 2023, India has over 1 lakh DPIIT-recognised startups, making it the third-largest ecosystem for startups globally. With this move, India would move further forward in its goal.
Encourage Entrepreneurship – Startups and entrepreneurs would feel more confident in raising funds without the tread of an additional tax burden. This would encourage more people to take the entrepreneurial route.
Boost To The Indian Economy – With more startups being funded, the economy would see a jump in the number of companies scaling up, leading to more job creation. Startups are known to generate employment, and by fostering their growth, India can further reduce unemployment levels.
Encourage Innovation In Critical Sectors – Removing the tax would enable more investments into high-risk, high-reward sectors like clean energy, biotechnology, and deep tech, where early-stage funding is crucial but scarce. Investors would be more willing to take the leap into these innovative areas if they were not burdened by the Angel Tax.
Improve Competitiveness & Global Expansion – With easier access to funding, Indian startups would have the financial bandwidth to scale more rapidly, allowing them to compete better on the global stage. The removal of the Angel Tax would allow Indian startups to pursue international expansion strategies more aggressively.
Also Read: What Mutual Funds Want From FM In This Union Budget 2024?
Angel Tax – The Conclusion
The Angel Tax was a crucial regulatory measure, which was aimed at preventing money laundering and ensuring fair valuation of shares. However, it affected startups, and investors, and potentially impacted foreign investments too.
The removal of the Angel Tax could serve as a major catalyst for the country’s burgeoning startup ecosystem, driving innovation, boosting investor confidence, and contributing to economic growth. We hope this article helped you understand all about the Angel Tax, why it was introduced, how it affected startups, and how its removal can help startups. If you wish to read more about stock markets, mutual funds, and personal finance, check out our other blogs.
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