Experts feel that start-ups face an even greater burden throughout the early years of their company because of the tax.
All eyes are on the Budget to be presented by Finance Minister Nirmala Sitharaman on July 23, 2024. In the start-up sector, a key expectation that is echoed by experts is the removal of the angel tax. Now, the Department for Promotion of Industry and Internal Trade (DPIIT) has backed the industry’s demand to remove the angel tax.
The term "angel tax" describes the income tax that the government imposes on funds raised by start-ups or unlisted businesses if their valuation surpasses their fair market value. Since the tax mostly affects angel investors, it is referred to as an angel tax.
In 2012, the tax was imposed by the government under Section 56(2) VII B of the Income Tax Act to prevent the laundering of funds. Through the Financial Act of 2023, the act was expanded to include foreign investors as well.
According to a notification released in April 2018, start-ups are not subject to the angel tax provided their total investment, including money from angel investors, does not exceed Rs 10 crore. The exemption can be obtained provided the start-ups receive a merchant banker's certification of their fair market value.
“Start-ups are looking for investments in the initial growing years of their businesses, and such investments are subjected to angel tax in the hands of the start-ups. Therefore, they end up losing a significant portion of their money by paying angel tax at a higher rate of approximately 30.90% to the government,” said Rubal Bansal Maini, Partner, Luthra and Luthra Law Offices India.
Experts feel that start-ups face an even greater burden throughout the early years of their company because of the tax. The main goal of encouraging adolescents to engage in start-up businesses is negatively impacted by the high taxes levied on the capital they receive from resident and non-resident investors.
“The angel tax has been a contentious issue for start-ups. While it is intended to curb money laundering, it has unfortunately created significant challenges for genuine investors and entrepreneurs. The tax adds an extra layer of complexity and uncertainty, making it difficult for start-ups to secure funding,” said Appalla Saikiran, Founder and CEO, SCOPE.
Experts also point out that eliminating this tax would also demonstrate the government's dedication to assisting new businesses, which would boost investor confidence.
Recently, several start-ups came under the radar of the Income Tax Department for their funding. The IT Department issued the notice under Section 68 of the Income Tax Act.
Section 68 of the Income Tax Act imposes a tax on any unexplained credit, deposit, or investment in a company. The Finance Act, 2023, expanded these angel tax provisions to include investments by non-residents in unlisted Indian companies if made at a price higher than the fair market value.
The angel tax under Section 56(2)(viib) taxes the money received by unlisted companies from investors. Section 68 requires these companies to disclose the source of the investor's funds. These rules ensure all funding received by unlisted companies is scrutinized, including legitimate investments, according to Maini. Eliminating this tax would make the Indian start-up ecosystem more attractive to both domestic and international investors, adds Saikiran.