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Angel Tax - All You Need to Know

Since the program “Make in India” has been launched, India has seen the advancement of many start-ups. New ideas by the young generation have made it possible for an idea to turn into reality. But before one starts a company, what is the major requirement one needs to fulfil? Money! Start-ups and new companies need huge sums and they procure this in the form of investment. The foreign fund, Venture capitalists and angel investors play a very important role in this.

These skilled professionals identify a high yielding start-up before anyone else and also agree to fund it. They identify diamonds in making and take their chances of investing in them. The investment made by these skilled professionals is called Angel Investment. Along with the modernisation, advancement and excessive yield of “Make in India” movement, there has been the introduction of “Angel Tax”. Angel Tax has been in news for a while and has faced a negative reaction from Start-ups all over the country.

What is Angel Tax?

Angel Tax is a tax levied by the government on start-ups who are funded by angel investment. As mentioned earlier, Angel Investment is the investment made by an Angel Investor. They recognise crude talent and if it fits their demands, Angel investors agree to invest in them. According to the laws of India, all start-ups who receive investment from an angel investor have to pay a certain percentage of the investment to the government. Angel Tax was first introduced in the year 2012 by the finance minister then Mr. Pranab Mukherjee. Angel Tax is a unique entity in itself, and it demands the start-ups to pay a definite sum in the form of tax.

The law under which Angel Tax comes states that the start-up needs to pay a certain part of the investment to them if the total investment value is greater than the Fair Market Value (FMV). The basis of Angel tax is that the extra investment that the start-up receives is seen as an income. And thus, according to the Income Tax rules of India, a start-up is liable to pay the Angel tax as a part of Income Tax.

Problems with Angel Tax

  • Only payments made by Indian Residents are liable for Angel tax. This means that if a start-up is funded by a resident Indian, then the start-up has to pay a certain share of this investment in the form of angel tax.
  • Since Angel tax demands start-ups to share a piece of their investment, some of their money is being lost in the form of tax. Most start-ups need a strong financial basis, to begin with, and Angel Tax seems to take a huge toll on start-ups.
  • Investments made by non-resident investors and venture capitalists are not liable for Angel Tax deduction.

Exemption from Angel Tax

Angel tax has caused a lot of problems to start-ups. They are losing a huge sum of their investment in the form of tax. This activity not only affects to start-up but also affects the investor. Seeing the unhealthy effects of Angel tax, people are trying to find grounds for exemptions. The government has finally notified the start-ups that there are conditions under which exemption is possible. This comes under Section 56 of Income Tax Law, 1961.

Solid grounds for exemption are:

  • The total investment made into a start-up should not exceed the Rs. 10 crore margin. This investment should include the investment made by angel investors as well.
  • In addition to the above condition, the start-up also needs to be approved and also receive a certificate from a merchant banker. The start-up is not supposed to estimate its own worth. This should be done by a professional- in this case, a merchant banker. The start-up should also obtain a seal of approval from an 8 membered inter-ministerial board for angel tax exemption.
  • The Angel investor funding a start-up should have a net worth of at least Rs. 2 crore. Along with this, it is absolutely necessary that the Angel investor’s income in the past three years should be at least Rs 50 lakh.

Investments under Angel Tax

Investments made by Residential investors are considered for Angel tax. In case a start-up is funded by a non-residential investor or a venture capitalist, it is not liable for taxation. Income tax law of India takes into consideration only the investment made by Indian residents.

Angel Tax Rate

According to the Income Tax Laws of India, 30.9% of the investment made to a start-up is charged in the form of Angel Tax. This means that a start-up is losing almost one-third of the investment made to it in the form of tax. Angel tax is taking a huge toll on start-ups. Not just this, the investors have also affected adversely. A start-up company already has a lot on its plate. They have problems to handle and losing a huge share of their investment in the form of tax is just not acceptable.

It is Easier to Understand Angel Tax with an Example

Imagine a start-up manages to get an investment of Rs. 100 crore from an investor. But according to Fair Market Value (FMV), it only deserves an investment of Rs. 50 crore. In that case, the remaining Rs. 50 crore is treated as an income and is charged for tax. As per the Angel Tax rate, 30% of Rs. 50 crore is the tax payable by the start-up to the government. This sums up to Rs. 15 crore.

A start-up losing so much money in the form of tax is a great loss on the part of the start-up. A start-up is in grave need of investment and spends every penny wisely. Losing such a huge sum in the form of tax has an unmeasurable impact on the company. Losing a huge chunk of the investment cannot be considered as a “dent”. This is something way beyond that.

Why is the start-up community opposing Angel Tax?

Besides losing a huge chunk of investment to the government, there are many factors which come into play. These factors adversely affect the true potential of a start-up. Some of these factors are:

The difference in calculation of Market Value

It has been observed that there is a significant difference in the methods of calculation of true market value. The approach that the government takes when calculating the market value of a start-up is way different from the approach taken by the start-up.

Many factors are considered when a company calculates its market value. The same factors are not considered when the government calculates the net worth of a start-up. Many factors which elevate the market value of a start-up are ignored by the government. And this in an unbelievably low market value.

On the other hand, Angel investors who make an investment consider the true potential of the company while making an investment. They know, if nurtured properly, a start-up can yield a lot. Hence, they invest a lot. This extra investment is seen in the form of income and is charged for tax, whereas this sum of money can be used by the company.

Impact on start-ups and Investors

A start-up loses a humongous chunk of its investment in the form of tax. This costs a lot and most start-ups cannot afford to lose such kind of money, that too at the very beginning. This puts a lot of pressure on the company.

For a start-up, it is not at all easy to gather funding. They come across a handful of willing investors after going through a lot of futile meetings and attempts. Once they nail a hot-shot investor, they want to put all their efforts and resources into building their company and making their product better. But instead, they lose a huge part of their investment to the government in the form of tax.

Angel tax also discourages many big investors from investing in small start-ups. Investors may see potential in the company, but they may not be willing to invest because they know a lot of it would be lost in the form of tax. Angel tax has instilled a sense of fear in the minds of investors. This has made it all the more difficult for start-ups to find proper funding.

Discouragement

The very purpose of “Make in India” was to promote start-ups and encourage the production and sale of goods made in India. But the application of Angel tax has proven to be big discouragement for start-ups. Start-ups are young, struggling companies. They do not have a lot of funding options. Also, they cannot afford to lose a large sum of their investment in the form of tax. Angel tax has made the survival of start-ups more difficult.

The adverse effect of Angel tax on investors has also proven to be a major drawback for start-ups. With a lack of investors, there is barely any chance that a start-up would live to see the day.

Conclusion

Despite the fact that Angel tax was started with good intention, it has suffered many backlashes. Angel Tax is deeply disapproved of by start-ups and investors alike. This has resulted in a steep decline in the progress of start-ups as they have spare funding. Investors, on the other hand, are also shying away from making investments in small companies. This has totally disrupted the balance and has made start-up survival all the tougher. There lies a long perilous road for start-ups.

Frequently Asked Questions

What is a Start-Up?

An entity is considered a start-up under the following conditions:

If it is incorporated as a private limited company or is registered for a partnership for a limited period. Along with this, the annual turnover should not have exceeded beyond Rs. 25 crore. Moreover, if it is working for the improvement of its product and can be a source of mass employment in future. Only then is a company considered to be a start-up.

What are the conditions for seeking “tax benefits” in the case of start-ups?

A Start-up should be a private limited company or a limited liability partnership. They should be working on the improvement and deployment of their products and services. Also, a start-up should also obtain a certified letter of approval from the inter-ministerial board of certification.

What is Angel tax?

Angel tax is the tax on the investment made in a start-up. This means that a part of the investment made to a start-up by an angel investor is liable for taxation.

What is the current Angel Tax Rate?

According to the latest news, the government charges no more than 30.9% of the investment made to a start-up as Angel tax.

How is Angel Tax calculated?

The government uses special methods to determine the market value of a company. It considers certain factors and comes up with a value which according to the government is fair. This is called “Fair Market Value” or FMV. If an investor invests more than FMV in a start-up then the extra money is considered as income. And this income is, according to the Income Tax Laws of India, liable for taxation. It should be considered that only the extra amount of money invested (above the FMV level) is considered for taxation.

Why was angel tax introduced?

Angel tax was introduced to minimise the problem of money laundering.

What are the grounds for exemption from Angel Tax?

For exemption, three conditions must be met. The total investment made to a start-up should not exceed Rs. 10 crore. The net worth of the investor should be at least Rs. 2 crore. Also, the annual income of the investor should be Rs. 50 lakhs or above. A start-up also needs to get itself certified from a merchant banker.

Why is angel tax opposed by start-ups?

Because of Angel taxation procedure, start-ups are losing a huge chunk of their investment to the government in the form of tax. This puts a lot of pressure on start-ups and has affected the survival of start-ups immensely.

How has angel tax affected investors?

Angel tax has deeply discouraged investors from investing in small scale businesses. This is because an unreasonable sum of their investment is not put into play. In fact, it is lost in the form of tax.

What is the Criteria for taxation?

The investment made by Indian residents into a start-up is considered for taxation. The investment made by venture capitalists of Non-resident investors is not considered for taxation.

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