The Indian Government has recently relaxed the rules for angel tax exemption for start- ups. With the introduction of amendment through the notification, start-ups are likely to have easy access to funding, which, in turn, will ensure ease in starting of new businesses, promote start-up eco-system, encourage entrepreneurship leading to more job creation and economic growth in the country.
What is Angel Tax?
It all started in 2012, when Honourable Finance Minister of India, Pranab Mukherjee, amended section 56(2) of the Income Tax Act. As per the amendment, funds raised by an unlisted company through issue of equity shares would get taxed to the extent the amount raised in excess of the fair market value. Such extra inflow was taxable as “income from other sources” under section 56(2) of the Income Tax Act and was charged at the corporate tax rate, resulting in an effective tax rate of more than 30%.
The tax on “income from other sources” was later infamously became popular as angel tax in Indian start-up ecosystem, as it brought down the angel investment in India.
Start-ups and angel investor soon started feeling the heat, when IT officers started sending the notices to start-ups and investor for not paying the tax where share trade value (Issue price) differed from the computed fair value.
“If the share issue price was greater than the fair value the start-up had to pay tax on the surplus issue price. Similarly, if the investments were made at a lower share price than that of the fair market value, the investor had to bear the tax over the deficit in valuation.”
The start-ups will be spared from the “Angel Tax” if it meets specific conditions.
Once start-up meet certain criteria, the inter- ministerial board will further go through every start-up, case by case and will decide whether the start-up under consideration is eligible for the angel tax exemption or not.
The board will constitute representative from Reserve Bank of India, stock market regulator SEBI, Central Board of Direct taxes (CBDT) and other relevant ministry.
The qualifying criteria are:
The aggregate amount of paid- up capital and share premium of the start-up after the proposed issue of share does not exceed Rs. 10 crore.
The investor or proposed investor has,
the average returned income of Rs. 25 lakhs or more for the preceding three financial year; or
the net worth of Rs. 3 crore or more as on the last date of the preceding financial year, and
The start-up has obtained a report from the merchant banker specifying the fair market value of shares in accordance with the procedure as laid down in Income Tax Act.
However, as per the notification, even if start-up meet all the mentioned criteria, the board keeps the right to decline said approval after providing reason.
Thus the latest notification will go in long way in establishing individual investor in par with venture capital funds and current trend of fall in angel funding may see reversal.