Angel tax exemption: Will it finally put a lid on the raging controversy?

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When the Government announced its 'Startup India' mission a couple of years ago, it generated a lot of excitement amongst the community of young entrepreneurs. The avowed objective of the scheme was to give a fillip to the startup environment through a combination of regulatory and tax sops. Two years hence, while the startup ecosystem is still going strong, of late some tax cracks have started surfacing. The biggest crack of them all that has spooked not only the startup founders but also the investors is the "angel tax" that is being slapped by the tax Department. In several cases, the Revenue has challenged the valuation at which the startups have received funding and has sought to tax the so-called 'excess share premium' u/s 56.

The Government, in an attempt to soothe the frayed nerves of the startup investors, has announced exemption from 'angel tax' where the aggregate amount of paid-up share capital and share premium of the startup after funding does not exceed Rs. 10 Cr. The big question is, will this put an end to the raging angel tax controversy or is it a case of 'too little, too late'? What are the three things the Government needs to do on the tax front to keep the startup momentum alive and kicking?

Dinesh Kanabar
CEO, Dhruva Advisors LLP

The comment has been co-authored by Ajay Rotti (Partner, Dhruva Advisors LLP)

While the move of the Department of Industrial Policy and Promotion (‘DIPP’) would certainly reduce the amount of litigation on account of section 56(2)(viib) of the Income -tax Act, 1961 (‘the Act’).  The DIPP notification has put a threshold of INR 10 Crore on the share capital and securities premium post the issue of share to angel investors.  Given the funding needs of a start-up, this threshold could be breached in no time.

If all the investments by the Angels into start-ups need to go through the process of approval from the eight member panel of the inter-ministerial board [to get exemption from section 56(2)(viib) of the Act], it would be a cumbersome process, and could go against the “ease of doing business” objective of the government. 

The Ministry of Finance (‘MoF’) would need to issue a suitable notification to give effect to the notification issued by the Ministry of Commerce and Industry (‘MCI’) vide Notification No GSR 364(E) dated April 11, 2018.  Further, the MCI would need to issue rules, procedures and online forms for making an application...

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Mukesh Butani
Founder, BMR Legal

Section 56 is like a 'catch all' provision which brings to tax income that does not or cannot be taxed under the other heads. Over the past decade the 'catch all' provision has undergone material changes, mostly intended to plug loopholes that were availed by taxpayers to legitimately avoid tax.

Such amendment was to tax premium charged by an investor if it made an investment in an unlisted company unless such premiums were justified by fair basis of market valuation. Besides the fact that making a determination on what is fair market value of shares of an unlisted company is a subjective exercise which entails assumptions, the 2012 amendment was like an anti-avoidance provision for ensuring that inbound investments via FDI was not round tripped to India or Indian promoters, of telecom businesses were not charging a premium to foreign investors at inflated values etc. The law however seems to have resulted in a barrier for startups, simply because when an angel investor or a VC fund and all forms of initial funding for new entrepreneurs make investment, the investor places a premium on the inventor and credibility of its business plan. Though, some...

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Ketan Dalal
Managing Partner, Katalyst Advisors

In order to appreciate the whole issue of Angel tax, one first needs to step back and see what the issue is.  Clearly, infusion of share capital can never be an income for the company of which the shares are subscribed, but unfortunately, Section 56(2)(viib), in a classic case of outlier legislation, has deemed it to be so, unless the fair market value is substantiated.  Firstly, this provision itself should be deleted because there are other remedies available to the tax department to address the issue in a situation where there is a doubt of an unjustified transaction, where share capital infusion actually does not represent the value of shares.  This could be happening in a few cases, but that should not be a reason to attack the universe of share capital infusions. And such legislation is clearly the antithesis of ease of doing business (or even thinking of business!)

Coming to Angels and start-ups, these are a great manifestation of entrepreneurship ; many of them will fail, but some of them will succeed and create great products and services.  These are very often initiated by young entrepreneurs, many of whom are innovative, but who...

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Gautam Mehra
Partner and Leader, Tax & Regulatory Services, PwC India

The comment is also co-authored by Harshal Kamdar (Partner, Tax & Regulatory)

Angel tax - time to say "au-revoir"

The angel tax for Indian companies i.e. share premium amounts "received" by the companies above their fair-value has created much controversy and a lot of avoidable pain for Indian corporates.  Aimed at curbing mischief, this provision has outlived itself, since tax provisions generally should not regard share premium as "income" for companies.

While the CBDT circular does give some relief for the start-ups (as defined), the rest of the universe (which would account for a significant majority of corporates - both by volume and value) are equally impacted by this provision.   Many technology companies raise funds based on their "idea" or "concept" and have a cash-burn in the initial years.  This provision creates unintended consequences for such companies, as explained in the following example.

1. Company A raised Rs 10 crores (including Rs 9 crores share premium) from an investor on 15 March 2017. 

2. It spent Rs 1 crore till 31 March 2017.

3. It spent the balance Rs 8 crores...

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Girish Vanvari
Founder, Transaction Square

Supporting Startups in their initial phases through tax and other concessions is paramount to fostering a startup ecosystem.  Over the past few years concessions have been gradually provided to encourage them.  The three year tax holiday, concessions under Section 79 and exemptions from Section 56(2)viib from fair valuation justification being the primary benefit.  The fair valuation issue for the fund raised,  is a big issue as valuations are subjective and startups raise money periodically and that too with increasing valuations.  In 2016,  the debate was put to rest for funds raised post that date.  However, there are many litigations pending for Startups funded prior to April 1, 2016.  Further,  there are also judicial precedents which state that investments include equity as well as preference and the Assessing officer has the power to investigate the fairness of the valuation.  This has led to widespread dispute with regard to the fairness of the valuations for startups funded prior to April 1, 2016.  To provide relief to startups, CBDT issued a circular saying that no coercive measures would be taken to recover the demand in these cases and steps would be taken for expeditious disposal of appeals.  Further to this...

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Hitesh D. Gajaria
Head of Tax , KPMG in India

Startup India - a premier initiative of the current Government intends provide benefits to eligible startups to promote entrepreneurship and foster innovation and development. This would result in employment generation and wealth creation in India. Tax incentives for promoting Start-ups have been given e.g. 100% tax deduction on profits for specified number of years, exemption from long term capital gains tax if such gains are invested in start-ups, relaxation on carry forward of losses even if change in shareholding in start-ups exceeds 51%.

Finance Act, 2013 introduced an anti-abuse provision – Section 56 (2) (viib), to curtail tax evasion and money laundering. It provided that if a closely held company issued shares at a price exceeding its fair market value, then such excess would be taxed as income in the hands of that company. This provision in colloquial usage is termed as “Angel Tax”

Department of Industrial Policy and Promotion – Ministry of Commerce and Industry, Government of India issued Notification G.S.R. 364(E) on 11 April, 2018, laying down conditions to be fulfilled by a Startup in order to be eligible for approval for relaxation from the rigours of Angel Tax. These conditions...

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T. P. Ostwal
Partner, T P Ostwal & Associates

In my opinion it is too late and also too little.We are a large country and our ministry has chicken hatred mind and hence can never think rationally and in a fair minded way .They always think how to stop progress of the country .Prime Ministers a great vision and is working hard to achieve these objectives but bureaucrats are not supporting his endeavour  

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