The changes announced by the government have considerably addressed the angel tax problem for startups, but procedural issues still need to be sorted out.
- The Minister for Commerce & Industry has announced major changes in the rules governing startups.
- These changes have profound implications for startups in terms of the dreaded angel tax issue.
- An entity will be identified as a startup upto 10 years since its incorporation and with a turnover of upto Rs 100 crore.
- Consideration for shares issued or proposed to be issued will be exempt up to a limit of Rs 25 crore.
Startups across India have been vociferously raising the angel tax issue with the government over the past few weeks. A number of these startups had received income tax notices in 2018.
Angel investments in these startups were liable to over 30% tax if their investments were over the fair market value (FMV) of the startup. This clause was introduced in Section 56 of the IT act under Budget 2012 and covers all companies from startups to large private enterprises.
The clause was criticised on the grounds that startups are being taxed on valuations, whereas most of them are yet to turn a profit. Moreover, FMV in itself is a tricky and vague concept that is open to differing interpretations. Some of these entrepreneurs started a Twitter campaign, which got highlighted once industry leaders like angel investor TV Mohandas Pai, Biocon Chairperson Kiran Mazumdar Shaw and Mahindra group Chairman Anand Mahindra flagged the issue.
I have to admit I didn’t know about this but it certainly goes against all the tenets of #StartupIndia It needs immediate attention or else all chances or building a rival to silicon valley in India will be lost… https://t.co/qOD0rHB3G3
— anand mahindra (@anandmahindra) December 18, 2018
Thankfully, the government has responded, and in a very positive manner.
Startups have a new identity
On February 19, Suresh Prabhu, Union Minister of Commerce & Industry notified some key changes in the rules for startups, which should act as a breather for most of them.
Following are some of the major changes in the rules for startups announced by the Minister:
- The definition of a startup has been revised. An entity will be considered a startup for upto 10 years from its date of incorporation/registration as opposed to 7 years currently.
- An entity will also be considered a startup if its turnover for any of the financial years since incorporation/ registration is less than Rs 100 crore. Prior to this, the limit was Rs 25 crore.
- Consideration received for shares issued or proposed to be issued will be exempt upto an aggregate limit of Rs 25 crore.
- Investments into startups by Non-Residents, Alternate Investment Funds – Category I registered with SEBI will be exempted beyond the limit of Rs 25 crores.
- A startup will be eligible for exemption if it is a private limited company recognised by DPIIT and is not investing in building or land or both, not being a residential house; loans and advances, other than those extended in the ordinary course of business; capital contribution made to any other entity; shares and securities; a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the startup; and jewellery other than that held by the startup as stock-in-trade in the ordinary course of business.
Ankit Mehrotra, co-founder and CEO, Dineout, welcomed the ruling as he stated:
“The blanket exemption from angel tax for startups is a welcome change for the industry as it would make it easier for indigenous innovation to thrive in our country.”
Padmaja Ruparel, Co-Founder, Indian Angel Network (IAN) & Founding Partner, IAN Fund commented:
“This will unshackle angel investing and bring in domestic monies for startups and help create the New India. The message that the government has given is that India will not only be the world’s startup hub but (hub for) startups which can go global, by increasing the turnover from Rs. 25 crores to 100 crores. This is a seminal move for angel investing and the foundation of Startup 2.0.”
Saurabh Srivastava, Chairman, Indian Angel Network praised the announcement, and felt it had set the stage for the next “wave of entrepreneurship” to make India the “number 1 startup nation in the world”.
The application for exemption has to be submitted to the Department for Promotion of Industry & Internal Trade (DPIIT), which will forward it to the Central Board of Direct Taxes (CBDT).
However, there are still procedural issues to be addressed. Vasudevan, partner, Lakshmikumaran & Sridharan Attorneys comments:
“The stated exemptions may provide much-needed relief to the relatively larger sized startups (having turnover upto Rs 100 Cr. instead of earlier threshold of Rs 25 Cr.) who may have been required to pay tax on premiums received on share subscription. (But) many of these reliefs will require amendments in the Income-Tax Act, 1961 and the startups may have to wait till that time to avail these benefits. It is to be noted that no relief is proposed in respect of section 68 of the Income-tax Act, 1961. So the startups will continue to carry the onus to establish the genuineness of the source of the investment made by the investors failing which the sums received on share application can be taxed by the department.”
Under Section 68, startups could be taxed if they are unable to explain the source of funds. This leaves considerable discretion in the hands of the assessing officer. So startup founders have even been asked to analyse the account books of their investors to ascertain the source of funds in some cases.
- Angel tax has come under severe criticism due to its implications for startups who are being taxed before they turn a profit.
- The new rules are welcome as they remove the devil of angel tax for most of the startups.
- This will definitely spur more investments and interest in the startup space.
- However, there are still some procedural issues to be addressed, in particular with respect to Section 68.