Where Does India Stand on Angel Tax? As the year comes to an end, startupreneurs display concern over the dreaded angel tax

The startup ecosystem in India has started gaining momentum not more than a decade back. Hence, making the dream of catching up with the Silicon Valley far-fetched but the ongoing government efforts for pushing new-age enterprises to innovate and create jobs had worked positively for the ecosystem. However, as the angel-cum-devil tax re-surfaced, it has brought out the hidden concerns of budding entrepreneurs and investors.

Over the past few days, many early-stage startups along with a handful of investors received notices from the I-T department to clear the taxes on the angel funding raised by them during the assessment year 2015-16. In some cases, people also received letters levying penalty on the unpaid taxes, taking the payable amount to almost 50 per cent of the total amount raised.

Government's Way Out

After facing the major backlash from startup founders and influential angel investors, the government has taken up the issue for further evaluation. Apart from setting up an expert committee for looking into all the taxation issues, the Central Board of Direct Taxation (CBDT) informed via a statement that "no coercive action or measures to recover the demands of completed assessment under income tax would be taken" against such firms.

A high-level meeting has reportedly been arranged between the Department of Revenue Secretary Ajay Bhushan Pandey, Department of Industrial Policy and Promotion (DIPP) Secretary Ramesh Abhishek and Central Board of Direct Taxes (CBDT) Chairman Sushil Chandra. Considering the commitment of Startup India initiative, the board is willing to show its support to startups in any way possible.

"It has been decided that the issue of recognition of these startups including the issue of premium among others will be decided on the basis of recommendations of a committee of eminent experts drawn from institutions like IITs, IIMs which will soon be set up by the DIPP on grant of tax exemptions and other connected matters," the statement by CBDT further added.

Big Voices

Joining the chorus against the angel tax notices, a number of influential personalities took their disapproval to social media including Mahindra Group chairman Anand Mahindra. "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 of building a rival to silicon valley in India will be lost," he tweeted.

Mahindra's response was a reaction to Former Infosys chief financial officer and angel investor Mohandas Pai's statement which claimed that the "Draconian' Angel tax is torturing startups and killing genuine innovation. Even Snapdeal founder Kunal Bahl expressed his displeasure against the fiasco stating that it will end up "destroying the most promising startup community in the world."

Major Concerns

The issue of angel tax continues to persist and is mentally and financially harassing the startup founders, investors along with the other people involved. "The process laid down for exemption from Angel Tax is tedious and cumbersome for startups. The Tax Officers are also not cognizant of the process of valuing startups and fundraising and therefore seek to tax the premium received by startups," opined the co-Founder of Venture Catalysts, Anuj Golecha.

The framework is in place but what the system needs is to be made more water-tight. PS Sreekanth who heads the investment team at Hyderabad Angels said, "While the government wants to make sure that every penny is traced, there are genuine startups which are getting affected." He is also a firm believer that the issue will soon be resolved as no one in the ecosystem has anything to hide.

While the policy is in place, the deteriorating quality of administration is a major concern. "Things have gotten bad to worse in terms of its administrative impact on startups and the degree of work they have to cope with in order to comply with what's going on. On the policy front, there is a mixed feeling due to the mutual consensus but on the administrative side, it continues to get worse," expressed Alok Mittal, the co-founder and CEO of Indifi Technologies Pvt Ltd.

Both the investors and entrepreneurs are hoping for the government to bring an instrumental change in the current policies to transform, safeguard and support the startup ecosystem. The co-founder and Managing Director of Innov8 Coworking, Ritesh Malik also believes that taxing angel investment into start-ups itself is a move detrimental to the entrepreneurial spirit as it is the first form of capital that flows into a budding start-up by an investor.

Most of the investors seem confused due to the lack of clarity on the matters. DIPP seems to be willing to give an ear but it has not translated yet to the corresponding behaviour at the tax department's end. An impending fear of investors backing out from funding the startups is looming over the enterprises. "A systemized solution needs to be figured, else this seemingly-small thing can completely destabilise the funding Indian startups get during their early stages," said Pranay Gupta, co-founder of 91springboard.

What Tax?

According to Section 56(2) of the Income Tax Act, money raised by unlisted companies through equity issuance from friends, family and angel investors is deemed as taxable "income from other sources', resulting in an effective tax rate of 30 per cent. Many startups have earlier come under the scrutiny of the Central Board of Direct Taxes for having raised capital above the fair value of their shares.

The tax was initially set up to ascertain the sources from which the funds are being generated. Due to the suspicion of angel investment being a means of turning black money into white, the government has been cautious of equity raised by independent investors. However, the tax is altogether going against the principle of paying a premium for a unique idea as there is no way an idea's value can be measured.

Exceptions! Exceptions?

In April this year, a mechanism was placed in order by Department of Industrial Policy and Promotion for startups to be exempted from section 56(2)(viib) of Income Tax Act. However, in order to be eligible, the startups need to qualify on certain parameters such as INR 25 crore turnover to get an exemption from income tax. Over 14,000 startups have reportedly registered to get the tax exemption but none has seen the light of the day so far.

Among the other tough conditions mentioned in the circular, it was mentioned that the aggregate amount of paid-up share capital and share premium of the startup after the issue of shares should not exceed Rs 10 crore and the angel investor should have average returned income of Rs 25 lakh or more for preceding three financial years among others.