Fear among startups and VC firms due to the new provision of Angel Tax, know what is said in the new provision
In the Economic Survey 2023, reforms were talked about in the interest of startups including tax and other rules. But, after the Union Budget was presented on February 1, startups and VC firms turned pessimistic. The government has proposed to change the rules of the Angel Tax. Startups can be hit hard by this change
A new Provision of Angel Tax: The government presented the Economic Survey on 31 January. In this, it was said about the ‘homecoming’ of those startups, which have left India and shifted abroad. In this, many changes were advised in the rules of capital flow and tax system for such companies to shift to India again. Startups and investors were seeing this as the first episode of big change. They have long been demanding that returns from investments in private firms be taxed at the same rate as returns from investments in listed companies. They were also seeking to simplify the tax treatment of employee stock options.
But, in the budget presented the next day i.e. on February 1, the government went into reverse gear in the matter of startup reform. The government tightened the rules for foreign investment in startups. This was done when startups are facing difficulties in raising funds. This problem is not expected to end soon. The budget states that the so-called angel tax regime will now be applicable to foreign investment in Indian startups as well.
This change in rules has worried everyone from startups to Venture Capital (VC) investors. Due to this, the difficulty regarding the funding of startups seems to be increasing. Let us know about this in detail:
What is angel tax?
The Angel Tax regime was introduced in 2012. It was implemented for the purpose of preventing money laundering. It states that if a startup raises funds from angel investors and this funding is more than the fair value of the shares, then it can be taxed. Tax authorities consider the premium paid by the investors as income. About 31 percent tax is levied on this.
For the last several years, investors and startups have been complaining about harassment from the tax authorities. He says that even in cases of genuine investments, the rules of angel tax are applied. Startups have been complaining that they get tax notices on angel investments raised 3 to 4 years ago. In some cases, the amount paid by the startups as tax has been more than the funding amount.
When the matter of Angel Tax was very hot in 2019, LocalCircles conducted a survey. It was reported that more than 73 percent of startups that raised capital between Rs 50 lakh and Rs 2 crore had received angel tax notices from the Income Tax Department.
Now, what has changed in Angel Tax?
Till now, two types of investors in startups were exempted from angel tax. These included VC firms registered as Alternative Investment Funds (AIFs) in India and all foreign investors. Through an amendment in the Finance Bill of Union Budget 2023, the government has abolished the tax exemption given to foreign investors. According to industry executives, 90 percent of the investment in startups in India comes from foreign sources.
What will be the effect of the change in rules?
The abolition of tax exemption on foreign investment will have a negative impact on the activities of startups. They will face difficulties in making salary advances, stock M&A, setting up subsidiaries, or contributing to ESOP trusts. A major impact could be that to avoid the impact of the Angel Tax, entrepreneurs may try to shift abroad, where such tax norms are not applicable.
What is the way forward?
Industry executives believe that the government will rethink this. VC funds are hopeful that they will be able to persuade the finance ministry to issue a clarification. The clarification will state that VC funds located abroad will be exempt from the new rules.
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