Bye, Bye Angel Tax. But Does it Really Solve Anything?
You're reading Entrepreneur India, an international franchise of Entrepreneur Media.
Funding,is the word buzzing all around as we walk into a room filled with Businessmen in any event. For any entrepreneur, raising funds for their startup is a difficult task. From running around for meetings with investors to late night calls attending to their due diligence process, there's a lot that needs to be done for the fundraising process.
Amidst all of this, for any new startup there had always been one demon that doomed upon an entrepreneur's life in the form of the angel tax. From petitions to discussions at forums, everyone had been talking about the angel tax and how it affected the fundraising process. Because of the angel tax, many investors refrained from investing in early stage start-ups slowing down the growth of these start-ups.
However, the Indian government just became the angel startups needed. The Income Tax Department has declared start-ups approved by an inter-ministerial panel are exempted from the tax which is levied on companies issuing shares to investors above their fair value, treating it as income from other sources.
For the same, the paid up capital and the share premium of the beneficiary start-up cannot exceed INR 10 crores after the share issue.
However investors aren't too happy. Entrepreneur India caught up with investors to know what the exemption really means for them and why the small step still doesn't make a big difference.
Not An Exemption; The Challenge Still Remains
The 2012 budget had introduced the concept of the Angel Tax as a part of the Income Tax Act. In accordance with the same, investments were taxed at 30 per cent. Under the same, any excess consideration received by a company will be treated as "income from other sources", if it issues shares at a price which exceeds the fair market value of the shares. The same does not apply if funding is received from VC funds, PE firms or a class of persons notified by the government.
Fundamentally, angel investors who are generally the HNI's investing in the early stage startups in their personal capacity play an important role in supporting the startup ecosystem, Angel Tax was a definite deterrent in such investments to be made pertaining to the tax it attracts, believes Rakesh Bhatia, Managing Partner, Beyond Strategy Consulting and Founder and CEO, TheCapitalNet. He said that exemption with its riders definitely help (only) the early stage companies get the seed capital like the good old days. "This however will not help the growth stage startups much considering the fact that the companies' post investment paid up capital has to be under INR 10 Cr or roughly USD 1.5 MM. The challenge still remains with the dependence on the merchant banks to value the startups," said Bhatia.
Agreeing with him Alok Mittal, Co-founder & CEO, Indifi Technologies and an active angel investor, said that this is really not an exemption for investors. Mittal said that the tax applies to startups that raise equity capital at a value in excess of fair market value, and the intent of the regulation was to curb illegitimate transactions. "Startups got covered in this as collateral damage. Globally, startups raise capital at higher than their fair market value, because that is the only way to incentivize and reward entrepreneurs for their ideas and hard work," he said.
However, the current mechanism continues to impose significant overhead on startups to qualify for the exemption. This is a space where entry barriers must be minimized, so that startups can operate easily and focus on building their business, believes Mittal. "If there is evidence of money laundering or other misuse of funds, the law of the land applies, and punitive action can be taken in those cases," he said.
Can it Put Angel Investors at Par with VCs?
Well, the answer seems to be a big NO from investors. Bhatia said that the Angels will continue to have a problem investing in later stage start-ups in addition to proving their eligibility and net worth every time they make an investment.
Parity with venture capital funds has not been the main concern for angel investors, said Mittal. "It is the extra burden that this tax imposes on startups, both financially and as an administrative overhead, which is at the core of the issue," he said.