Angel Tax Exemption- A Policy Analysis

What is angel tax?

Angel tax refers to the income tax payable by unlisted companies on the capital raised via them by issuing shares through off-market more than the fair market value of the company; the excess realization is considered as income and therefore, taxed accordingly. This happens because when a company is doing extremely well operationally then the investors are highly interested in buying the shares when the shares are first issued. In this case the company, knowing its brand value and market expectations, may issue shares at a price way higher or over what a comparable stock may be granted at in the market and this makes up the excess realisation and taxable portion. The Angel Tax only applies to investments made by a resident investor and is not applicable in the event that the investments are made by venture capital funds or non-resident funds. 

This tax was introduced in 2012 in the form of section 56(2)  by then finance minister Pranab Mukherjee to capture laundering of funds. 

Purpose and benefits of Angel Tax

The tax was imposed to prevent money laundering and identify unexplained cash credits. It was adopted to discourage the practice adopted by the taxpayers of subscription to shares of closely held companies at an unjustified premium compared to its fair market value. Section 68 gives details about the procedure to be undertaken for the unexplained cash credits. 

Criticisms of the angel tax

Initially the tax came under the criticisms of investors as it seemed to be startup unfriendly and cumbersome. Startups' fair market value which forms the base for determining the tax has subjective aspects because the startups valuation may differ about its share as it might be based on the simplest things like projected returns. The imposition of tax stops the budding entrepreneurs from growing, fearing the huge amount of tax with no proper credentials of evaluation and high penalty charges.

It again went into headlines with the government's decision to give exemption to startups, the target group that it affects the most to encourage more startups and creation of jobs. However a major issue started recently with angel investors receiving notices for paying the tax.

Condition for availing exemption

A startup would be entitled to apply for an exemption from Angel Tax under Section 56 (2) (vii) (b) if the following conditions are met: 

 1. It has been recognised by DPIIT(Department for Promotion of Industry and Internal Trade) as a legitimate startup

According to the DPIIT notification , a company is considered a new company for a period of 10 years from the date of incorporation, as

      (i) its turnover has not exceeded 100 million rupees (INR one billion) for each year since formation           

      (ii) is not formed by the outsourcing or rebuilding of an existing business. In order to be recognized as a startup, the startup must submit an online application (along with certain mandatory documents) via the mobile application or the portal configured by the DPI.

 2. The total amount of paid-up share capital and initial bonus following the issue or proposed issue of any share, if any, will not exceed 25 million rupees.  With this condition in mind, investments by (i) non-residents; (ii) venture capital company or venture capital fund; and (iii) publicly traded companies that meet certain criteria based on net assets/sales will be excluded. 

 3. A start-up may not invest in certain specific assets for a certain period of seven years from the end of the financial year in which the shares are issued at a premium. These assets include 

• Real estate  

• Loans and advances 

• Stocks and securities 

• Contribution of capital to other companies 

• Certain assets such as jewellery, drawings, paintings, works of art, gold bars, etc.

   4. Startups on Form 2 must Submit a self-declaration to DPIIT  On Form 2, startups must certify and declare that they meet the above conditions. The DPIIT then forwards the opinion to the CBDT.

Effects of Angel Tax Exemption

India is at a very crucial stage and in its high time with a large number of opportunities opening up through various initiatives and programmes like MAKE IN INDIA launched by the government. At this stage, the government's decision to relax the angel tax impositions has given a boost to startups which had plunged down until 2018 substantially with angel tax being a major reason behind the same. It has again instilled confidence and faith in Indian small investors who had suffered a major setback as a result of the imposition of angel tax. Under section 80 IAC of the IT Act, tax deduction rules state that deductions will be given at 100% on its gains for 3 out of 7  successive assessment years. They can also access CBDT’s special cell devoted to solving startups issues. There is also a provision under section 79 for setting off previous years losses. It also provides benefits to investors for investing in equity shares of a startup.

Review

Startups are an important part of any nation’s economy. It has gained popularity especially post covid pandemic, for some as a new business idea and for others as a generation of employment opportunities. They also bring about technical development and new ideas from worldwide. Such an important part of the economy cannot be overlooked and thus angel tax exemption becomes the need seeing the adverse impact that its imposition had on the startups as a part and economic structure as a whole. At this stage of development, India cannot take a risk in such a crucial sector. This definitely has its own cons and gives a big push to corrupt people who invest in businesses to make their black money white. But rather than imposing angel tax blindly, the government can follow stringent measures of tracing the corruption and providing an exemption from the tax to only deserving individuals by following a proper procedure to ensure that exemption is available to only deserving firms. A bit of freedom and support to startups can help them become business giants over a period of time.

The steps taken by the government are good and there are good prospects that this can actually help give a boost to the startups and economic structure by keeping a due check on money laundering practices.

Reference List

1. What is Angel Tax – A Guide to Angel Tax. (2021, October 4). Angel One. Retrieved November 18, 2021, from https://www.angelone.in/knowledge-center/income-tax/what-is-angel-tax

2. ET Bureau. (2018, December 22). ET in the classroom: What is Angel tax? The Economic Times. https://economictimes.indiatimes.com/news/economy/finance/et-in-the-classroom-what-is-angel-tax/articleshow/67202362.cms

3. paisabazaar. (2019, September 1). what is angel tax. Paisabazaar.Com. https://www.paisabazaar.com/tax/angel-tax/

4. TaxGuru Consultancy & Online Publication LLP. (2020, January 5). Angel Tax: Blessing or Curse. TaxGuru. Retrieved November 18, 2021, from https://taxguru.in/income-tax/angel-tax-blessing-curse.html

5. T. (2021, September 10). Enjoy tax exemptions as an angel investor and while enjoying average ROI of 22%. Tomorrowmakers. https://www.tomorrowmakers.com/tax-planning/enjoy-tax-exemptions-angel-investor-and-while-enjoying-average-roi-22-article

6. Chakraborty, S. C. K. (2019, February 19). Angel tax exemption a good effort, but more needs to be done: Industry. Www.Business-Standard.Com. https://www.business-standard.com/article/companies/angel-tax-exemption-a-good-effort-but-more-needs-to-be-done-industry-119022000015_1.html

7. T. (2021a, February 1). Understanding the Concept of Angel Tax & Its Impact on Startups. Taxmann Blog. https://www.taxmann.com/post/blog/790/understanding-the-concept-of-angel-tax-its-impact-on-startups/

8. Chhabra, S. (2021, July 7). What is Angel Tax : A Complete Guide of Angel Tax. Provenience. https://provenience.in/blog/what-is-angel-tax/#:%7E:text=Angel%20tax%20is%20levied%20on,income%20and%20therefore%2C%20taxed%20accordingly.

9. Shaktawat, R. (2019, March 13). 'Angel tax' exemption for Start-Ups – conditions relaxed. Mondaq. https://www.mondaq.com/india/corporate-and-company-law/789386/39angel-tax39-exemption-for-start-ups-conditions-relaxed