Anushruti Singh
Today, in a landmark announcement during the Union Budget 2024-25, Finance Minister Nirmala Sitharaman declared the abolition of the controversial angel tax. In her budget speech, she stated, “To bolster the Indian start-up ecosystem, boost the entrepreneurial spirit and support innovation, I propose to abolish the so-called angel tax for all classes of investors.”
Angel Tax: A brief explainer
What is Angel Tax?
Angel tax is a term used to describe the tax levied on the capital raised by unlisted companies via the issue of shares, where the share price is considered in excess of the fair market value. The tax is applicable to the amount received from angel investors. The concept of the angel tax was introduced in India in 2012 and was introduced under Section 56(2)(viib) of the Income Tax Act, 1961, this provision aims to tax the premium amount received by startups when they issue shares to investors above their fair market value.
Why was Angel Tax introduced in India?
The primary intent behind introducing the angel tax was to curb money laundering activities and prevent the generation of unaccounted income. The government suspected that many companies were routing black money through the issuance of shares at inflated prices. By taxing the premium amount, the authorities aimed to deter such activities and ensure transparency and accountability in financial transactions.
Why Angel Tax became challenge for startups
While the introduction of angel tax was well-intentioned, it posed significant challenges for startups. Here’s why:
- Valuation disputes: Determining the fair market value of a startup is complex and often subjective. Startups, especially in their early stages, may not have substantial revenues or profits, making it difficult to justify their valuations. The tax authorities’ assessment of fair market value often differed from the valuations agreed upon by investors, leading to disputes and tax demands.
- Funding hindrance: The angel tax discouraged many investors from funding startups due to the potential tax implications. Investors were wary of investing in startups that might later face tax scrutiny and heavy tax liabilities, thus limiting the flow of much-needed capital to these businesses.
- Cash flow issues: For startups, which often operate on tight budgets, unexpected tax liabilities can severely impact cash flow. Paying angel tax on the funds received meant that startups had less capital to invest in growth, research, development, and scaling their operations.
- Administrative burden: Dealing with tax authorities, providing extensive documentation to justify valuations, and navigating the legal complexities added an administrative burden on startups. This diverted their focus from core business activities to compliance and legal battles.
- Inconsistent implementation: There were instances of inconsistent implementation of the angel tax provision, with some startups being targeted more aggressively than others. This lack of uniformity created an uncertain investment environment.
Given these challenges, over the years, the angel tax became a contentious issue, with numerous startups receiving tax notices and being embroiled in lengthy disputes. The tax was perceived as a deterrent to investment, creating an environment of uncertainty and fear among both domestic and foreign investors.
Now with the government announcing to scrap the tax has been met with widespread acclaim from the startup community and industry experts, who believe this move will significantly boost investment sentiment and support the growth of the Indian startup ecosystem.
Commenting on the announcement, Anil Joshi, Managing Partner, Unicorn India Ventures says “It was long pending, glad that Hon. FM has heard industry voices and has finally abolished it. This will certainly help in expansion of angel investment in India and will take away a lot of burden from the minds of everyone on tax notice for tax paid investment. This will also free up a lot of domestic capital and improve the funding sentiment in a strong way,”
Anirudh A Damani -Managing Partner – Artha Venture Fund speaking from a VC perspective said it will enhance ease of doing business. “The removal of the angel tax will make it significantly easier for us to complete transactions faster and streamline the investment process. Previously, the requirement for income tax officers to understand and assess valuations led to unnecessary conflicts and delays, involving CAs, valuers, and tax officials,”
“Valuation assessments were never meant to fall within the purview of income tax officers, and this change eliminates those complications. This simplification allows us to focus on our primary job—investing in and supporting innovative startups—without the burden of navigating through cumbersome tax regulations,” he points out.
Ratna Mehta – Managing Partner, Fundalogical Ventures believes the decision will provide a boost to the budding Indian startup ecosystem.
“It will encourage the flow of capital without tax leakages, especially relevant at a time when the funding crunch is impacting startup liquidity. It is key to establish India as an innovation hub and leader vs follower for new and breakthrough ideas,” he says.
Appalla Saikiran, Founder & CEO, SCOPE feels the announcement marks a pivotal moment for India’s start up ecosystem.
“The abolition of the angel tax is a game-changer, eliminating a significant hurdle for early-stage start-ups. This tax was a deterrent for investors due to its complex and punitive nature. By abolishing this tax, the government removes a major regulatory obstacle, making it easier for start-ups to secure funding without facing tax-related hurdles. This move is anticipated to enhance the attractiveness of investing in start-ups and stimulate greater investment activity,” he says.
Manoj Agarwal, Managing Partner, Seafund also weighs in saying that this is the biggest take away from the Budget is removal of angel tax.
“This will lead to ease in raising funding for early stage founders and will encourage more early stage investors and angels to look at startup investing as a fruitful asset class. In our view, this single announcement is a small step in the direction of making angel investment accessible for people with investment corpus which currently goes to markets and Mutual funds,” he comments.
Startups are also hailing the step. Chris George, Co-FOunder & CEO at QubeHealth says, “Abolishing the Angel Tax is a much needed welcome news to all Indian Startups. The ability to fuel our startup economy that is generating so much employment is a step in the right direction.”
