The country is on its way to 'Start up India', and to make sure entrepreneurs find the least hurdles, the government is acting out. The most recent addition to their startup policy, the government is taking off the burden of tax investors had to pay when providing funding to a startup.
Under the government approved plan by Prime Minster Narendra Modi announced in January this year to give boost to entrepreneurship and job creation in the country, a startup or investor would not have to pay tax on funding even if it exceeds the face value.
Under Section 56(2) of the Income-Tax Act, residential angel investors domestic family offices or domestic funds who could not be registered as venture capitalist had to pay a tax on the investment they made. Taxable as "income from other sources", a corporate tax of 30% was levied on the investors. The Income Tax act states,
“Any consideration received by a company (startup) from a resident, against issue of shares, exceeds the fair market value of such shares, such excess consideration is taxable in the hands of the startup, as an income.”
Also, venture capital funds registered with Securities and Exchange Bureau of India (SEBI) are exempted from this tax. Tax was enacted with the good intention to make the system transparent and keep a check on the inflow of black money; the tax has turned out to be more like a burden an investor had to bear before making an investment.
How it affected investment
A startup receives angel funds with a major part of it dependent on the idea itself. Here the investor takes a chance on the statrup by trusting the team and technology behind it. Their money is stuck! Also, at this time of funding drought, having a tax to pay is an extra amount the startup could have used in setting up their company. Due to all the trouble it causes, venture capitalists have been lobbying for removal of this tax, terming it a big deterrent to investments.
How it will affect future investments
Now that Central Board of Direct Taxes has issued a notification to this effect, exempting startups raising investments from the rigors of Section 56(2)(viib), startups and investors can breathe with at least one hurdle off their way.
The tax was not burden when thinking monetarily, but being based on valuations, it was an unfair move. As there is no definite way to measure a startup’s valuation, the data that goes public about the company dependent on the mercy if IT officer who would decide if the valuation is justified. Now trying not to sound too cynical, some of these officials will have the tendency to get some money ‘under the table’ to show increased valuations of some startups. Now the higher valuation you have, more chances you have of getting a funding, so that would lead to bribing IT officials.
Hence, this tax was contradicting itself by increasing chances of corruption while trying to curb it. The tax sure will bring more transparency in the system.
"This has been long awaited and is a very welcome step. The abolition of this so-called 'angel tax' has been a long-standing demand of the industry," said Amit Maheshwari, partner, Ashok Maheshwary &Associates LLP to ET.