The government has made changes to the procedure for angel tax exemption. But the tax should ideally be done away with for good.
The angel funding issue was a major sore point that startups had expected the government to address in the Interim Budget 2019. However, the issue was not a point of discussion during the FM’s speech.
According to a survey by Indian Private Equity and Venture Capital Association (IVCA), IT notices under ‘angel tax’ have been sent to around 2,000 startups who had secured funding from angel financiers, private equity (PE) and venture capital (VC) funds. The survey was conducted to ascertain the impact of angel tax, information on which was sought by the government.
These accounted for around 73% of the 2,883 respondents surveyed. It is anticipated that there are around 7,000 startups in India. They had got the notices because they had raised money above the ‘fair market value’ or from unknown sources. The tax is applied on the premiums that are paid by investors in startups.
It is indeed confounding that tax officials are raising eyebrows on the growing valuations of startups – they feel this is not warranted when compared with revenue growth of these companies. According to the revenue department, if the capital raised exceeds the fair market value as other income is taxable.
When the investor is not Indian, it gets worse. The department has designated such investments as ‘unexplained cash credits’ and imposed 30% tax in previous notices. While Section 56(2) (viib) deals with valuations, Section 68 deals with unexplained credit.
Around one-fourth of the startups who were served notices have got them under both sections. Moreover, 95% of the cases had investments of less than Rs 10 crore.
Sachin Taparia, founder and chairman, LocalCircles, feels that the angel tax should be removed for government-recognised startups. He adds in an interaction with ET, “And to do the same, startups are also willing to submit a set of 4-5 documents which can easily help DIPP and CBDT differentiate them from shell companies but this devil of angel tax for startups must go away.”
In the DIPP notification, a startup now has to apply to DIPP for exemption from angel tax Section 56(2) (viib) under with the required documentation. DIPP will submit the application to CBDT which has to convey its decision within 45 days. IVCA in turn has proposed that a blanket exemption be allowed for startups that have raised funds of upto Rs 10 crore.
The fact is that startup valuations are an extremely tricky domain. They are by nature dynamic, and will depend on a lot of factors like the innovative product/business model, dynamism of founders, prospective market potential and potential futuristic earnings. If the government is really looking to curb circulation of money, a better way could be to focus on the investors holding unaccounted money rather than the startups.