Angel Tax – Simplifying the tax life of a Start-up

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A lot has been said about angel tax over the years. While the technocrats are well aware of the topic, most of the non-technical start-ups have no clue until they get a surprise from their VC, CA or a tax officer. Let us look at simplifying the topic and understand how some air of confusion has been cleared by bringing in an important carve-out in the tax provision for Start-ups.

What is a Start-up tax / Angel tax – Section 56(2)(viib)?

When start-up issues a share above face value (generally INR 10), such shares are said to be issued at a premium. If the value of such shares issued by a start-up is higher than the Fair Market Value (FMV) of the shares (as determined through specified valuation methodologies), then the difference between such issued price and the fair market value is considered as an income in the hands of the issuer of the shares (i.e. start-up).

Such a provision was brought in to curb black money investment in any companies, which are not worthy of such investments. In short, if any company is receiving funds from an investor which the company is not worthy of, then the difference between the invested funds and the worth of the company is considered as income in the hands of the company.

What was the problem?

The answer to the question could be given in one word – ‘Valuation’. Valuation for the purpose of FMV is not a mathematical uniform formula to determine the value of shares of a company. The valuation depends on the facts and circumstances of a case and depends on the assumptions, forecasts and projections drawn by the company. Therefore, given the subjectivity of valuation, it is often challenged by the tax authorities to aggressively impute income-tax on something that is capital in nature. With this the whole purpose of curbing of black-money goes for a toss, thereby impacting the most important strengths of the industry ie. start-ups. Start-ups are companies which may not have historical backgrounds in fixed revenue flows and therefore valuations could be based on market situations, the attractiveness of idea and also the competition amidst the investors etc.

Therefore, start-ups and the angel investors were the primary targets of such provision and the industry represented to the government for several years to water down the strict provisions. That is how a term angel tax/ start-up tax was coined.

Relief offered ( Notification dated 16 January 2019)

A start-up to get an exemption from the applicability of the above provisions [exception to Section 56(2)(viib)] if:

(i) the start-up is recognised by Department of Industry Policy and Promotion (DIPP)

(ii) The aggregate amount of paid-up share capital including premium does not exceed INR 10 crores

(iii) The investor has minimum returned income of INR 50 Lakh or more in previous FY (preceding investment)

(iv) Net worth of such investor exceeds Rs 2 cr or equivalent to the amount of investment to be made in the startup, whichever is higher (as on last day of FY preceding investment)

(v) Application for approval to be made to DIPP in Form -2 and to be accompanied by documents specified

CBDT within a period of 45 days from the date of receipt of application from DIPP may grant approval to the Start-up.

Conclusion:

“It is better later than never” could be a good inference from the notification. The notification would bring a lot of certainty to the start-ups at the cost of compliance. With the Government’s role of being an administrator, the compliance and transparency are bound to increase and it is in the benefit of every business to take such compliances with utmost sincerity.

Would be happy to clarify and help in case of any doubts.

Regards

CA. Akshay Kenkre

akshaykenkre@transprice.in

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