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Angel Tax has been amongst the most used terminologies in the context of the Indian startup ecosystem over the past decade. This was a tax that, until recently, had largely been seen as a stumbling block in the way of their growth and survival, as it chewed into the early-stage capital when money laundering was at its peak. However, the recent reforms that the Indian government has developed, especially abolishing the Angel Tax from FY 2025-26, will encourage entrepreneurship and invite investments in the country’s growing startup landscape.
In this guide, we explain what Angel Tax is, its history, implications on startups, and exemptions available for Angel Tax.
Angel tax is the tax charged on the investments received by the unlisted startups from the angel investors if the investment made exceeds the startups’ Fair Market Value. According to Section 56(2)(viib) of the Income Tax Act, 1961, any amount received by a startup in excess of the FMV of its shares is considered “income from other sources” and thus is liable to taxation. The tax is chargeable at 30.9%.
The meaning of Angel Tax involves attempting to avoid money laundering by ensuring that money, for which accounting is not done, does not go into the economy through certain inflated valuations. Wherein, in practice, it was found that a lot of startups were stuck in this tax since valuations are subjective; therefore, this would result in an unfair burden of tax on them.
Let’s clarify Angel Tax with an example:
For instance, if an angel investor invests ₹20 crore in a startup whose FMV at investment is ₹15 core, the differential of ₹5 crore is considered income and taxed at 30.9%, thus leaving the startup to bear ₹1.54 crore of tax burden.
This is a hefty tax that eventually shrinks the capital available for startups and forces many growing ones to divert capital meant for growth to paying taxes.
The meaning of Angel Tax is inherently preventing black money from coming into the economy in the name of high-value startup investments. When introduced back in 2012, prevention of tax evasion by startups and individuals through inflated valuations that allowed money laundering was the primary focus for the government.
Angel Tax, designed as a noble idea, therefore became a controversial tax. Most startups, who were genuine in their investments, found the process quite grueling because it was an open battlefield of valuation between the investor and the tax authorities in many cases. The imposition of tax also caused worry among angel investors regarding the tax consequences arising from inflated valuation in the startup companies where they had invested.
The imposition of Angel Tax was a strong blow to the startup ecosystem of India in many ways:
Startups depend on angel investors to acquire growth in the initial stages. The wealth tax on overvalued investments frightened angel investors from funding startups, which in turn stunted the growth.
FMV of a startup’s shares is mostly subjective in character, and its assessment by the tax authorities might not align with that by the startup or an investor. This triggered a spate of litigation cases.
Many start-ups found themselves losing a substantial portion of their early-stage capital for Angel Tax, which otherwise could be utilized for scaling up or product development.
These challenges led to an industrywide call for criticism as equally startups and investors called for reforms.
What saw the furore grow was when the Indian government issued a series of reforms-the most notable being those in the Union Budget 2019-to ease the pressure of Angel Tax and create a more startup-friendly atmosphere.
The Startup shall be incorporated in DPIIT. This provides the facility of filing for a tax exemption.
Aggregate amount of paid-up capital and share premium after the issue of shares by the eligible startup shall not exceed ₹25 crore. Also, funding received from some categories of entities such as venture capital firms and non-residents is also excluded from the limit.
The FMV of the startup shall be done through a merchant banker so that it is registered as a merchant banker with SEBI.
The annual turnover of the startup does not exceed ₹100 crore in any of the previous financial years.
Angel investors need to comply with certain financial limits. Their annual income must not exceed ₹25 lakh and their net worth ₹2 crore during the last three fiscal years.
These conditions came as much-needed respite to startups, enabling them to raise funds sans the threatening specter of Angel Tax. Moreover, in her Union Budget for 2024, Union Finance Minister Nirmala Sitharaman declared the total abolition of Angel Tax from FY 2025-26, henceforth-the government said-to promote innovation and growth in the ecosystem of startups.
Angel Tax has been termed a landmark reform in India’s startup ecosystem. Quite essentially, by removing the tax on all classes of investors, the government has given a strong signal to domestic and international investors that India means business when it comes to promoting its startups.
Here’s what abolition essentially means for startups:
With no tax levied on valuations in excess of the actual amount invested, there will be more angel investors willing to invest, thus more early-stage money will come to Indian start-ups.
Now, with no fear of paying away the hard-earned capital as taxes, start-ups can actually focus on scaling their businesses. Removal of Angel Tax-an encouragement to innovators to create something without fear of tax liabilities.
The valuation process would be simplified and, therefore, less vulnerable to disputes with tax authorities.
This reform is likely to further cement India’s status as a startup hub globally.
It’s been a long-standing bane in the life of India’s startup community, not to mention tumult over funding and growth. With the abolition of the tax in the Union Budget of 2024, it is finally time for India’s startups to think of a brighter future. Thus, Angel Tax becomes a thing of the past, and issues related to it are expected to simplify and reduce outlay from the financial burden. It is also expected that this move will spur innovation, attract more investments to Indian startups, and bring these firms at par with other global startups.
Understanding what Angel Tax means, its implications, and the exemption related to it will help both the entrepreneurs and the investors move ahead into the evolving startup ecosystem in India.
Angel Tax is a tax levied on unlisted startups that receive investments greater than the ‘fair market value’ of the startup from angel investors. It charges 30.9% on the excess investment as an income tax.
Exemption of Angel Tax: Any startup that gets registered with DPIIT has to see that its paid-up capital amount does not cross ₹25 crore and the FMV value of its company is taken into consideration by the certified merchant banker. Annual turnover of the startup to be generated should be less than ₹100 crore.
Yes, as per the Union Budget 2024, the Indian government has announced abolishing Angel Tax for all investor classes from FY 2025-26.
Angel tax was introduced in 2012 to avoid money laundering activities that used to inflate the valuation of startups to bring unaccounted money into the economy.
The Angel Tax became a headache for startups, coming in the form of lesser investments, valuation disputes, and loss of big capital. Hence, its abolition from FY 2025-26 would definitely boost the startup ecosystem.
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