Centre seeks to relax angel tax

Published: 28th Sep, 2023

Context

Recently, Rule 11UA under the Income Tax Act has been amended bringing relief to prospective foreign investors in startups.

What is Angle tax?

Angel tax is essentially the tax that unlisted companies (startups) are liable to pay on the capital they raise through issue of shares.

About the update:

In the Budget 2023-24, the government has eased some of the provisions of the angel tax introduced on investments into startups by non-resident investors.
It has introduced five different valuation methods for shares and offered a 10% tolerance for deviations from the accepted share valuations.
The introduction of five alternative valuation methods for the valuation of equity shares, which so far could only be valued based on NAV and Discounted Free Cash Flow methods, is more flexibility to merchant bankers for the valuation of a company.

Taxation of Startups:

Fair Value:

Fair value is the estimated price at which an asset is bought or sold when both the buyer and seller freely agree on a price.
To determine the fair value of a product or financial investment, an individual or business may look at actual market transactions for similar assets, estimate the expected earnings of the asset, and determine the cost to replace the asset.

In 2012, Section 56 (2) of the Income Tax Act was amended to curb money laundering practices.
It updated that any unlisted company (usually startup enterprises) in receipt of investment which is above the fair value will have to treat the extraneous capital as ‘income from other sources’ which would be identified and taxed.
In an announcement by the Finance Ministry in 2019, startups registered under Department for Promotion of Industry and Internal Trade (DPIIT) are exempt from angel tax.
All that a startup needs to do is apply for eligibility to DPIIT along with necessary documents and returns which will then be sent to CBDT (Central Board of Direct Taxes) for final approval.
The CBDT reserves the right to decline the exemption status for a company.

Criteria for Exemption:

Now, according to the revised rules, the companies need to meet certain requirements to be eligible for the exemption-

Paid-up capital, along with the premium on shares, cannot exceed 10 crore post-issuance of shares.
Earlier administration required a merchant banker must certify the startup’s fair market value. But this rule has been made away with since 2019.
The lower limit for investor’s net worth has been fixed at 2 crore and average income cannot be less than Rs. 50 lakh in the last three consecutive financial years.

How Foreign Direct Investment (FDI) works in India?

A Foreign Direct Investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country.
FDI lets an investor purchase a direct business interest in a foreign country.
Significance: Apart from being a critical driver of economic growth, FDI has been a major non-debt financial resource for the economic development of India.
Routes of FDI:
Government Route:
- In this, the foreign entity has to take the approval of the government.
- The Foreign Investment Facilitation Portal (FIFP) facilitates the single window clearance of applications which are through approval route.
- It is administered by the Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry.

Foreign Investments and Impacts on Start-ups:

Economic Growth: Foreign investment can fuel economic growth by providing capital, technology, and expertise. Startups often benefit from foreign direct investment (FDI) as it can fund research, development, and expansion.
Access to Global Markets: Foreign investors can provide startups with access to international markets, helping them expand their customer base and reach global audiences.
Ecosystem Development: Foreign investment can foster the development of a robust startup ecosystem by attracting talent, mentors, and resources, creating a favorable environment for innovation and entrepreneurship.

Challenges

Ownership and Control: Startups must consider the trade-off between accessing foreign capital and retaining control. Heavy reliance on foreign investment may lead to loss of ownership and decision-making power.
Regulatory Hurdles: Different countries have varying regulations and restrictions on foreign investment. Startups need to navigate these legal complexities, which can be time-consuming and costly.
Cultural and Market Fit: Startups entering foreign markets through investment must ensure their products or services align with local cultures and preferences to succeed.

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