Modi’s quick-fix for angel tax isn’t helping Indian startups much

Big bang changes required.
Big bang changes required.
Image: Reuters/Sivaram V
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The Narendra Modi government may have finally extended some relief to India’s startup community, simmering with anger and tension over the imposition of angel tax. But the move will hardly protect companies from tax harassment.

Yesterday (Jan. 16), the Indian government said startups seeking an exemption from angel-tax notices will not require certification from an inter-ministerial body anymore. Instead, new applications will have to be filed through the department of industrial policy and promotion (DIPP), which will be evaluated by the central board of direct taxes (CBDT) in 45 days.

Angel tax is triggered when a startup receives an equity infusion in excess of “fair valuation.” Tax authorities treat the premium paid by investors as income, taxable at 30%.

Since December 2018, a number of startups and organisations, including NASSCOM, the Indian Private Equity and Venture Capital Association (IVCA), the Indian Angel Network, iSPIRT Foundation, and LocalCircles, have written multiple letters to DIPP and CBDT demanding the abolition of angel tax.

Their concerns have been quelled time and again by the government, which promised a solution. In December, the CBDT issued a notification assuring that no coercive action would be taken in the follow-up of income tax (I-T) notices and demand-orders issued to startups. However, the notification did not deter assessing officers from generating fresh IT notices and several startups received notifications for angel-tax evasion the same month.

“It (the government’s latest move) is a step in the right direction, but the government hasn’t addressed a number of other issues,” said Sachin Taparia, chairman and founder of citizens engagement forum LocalCircles.

The problem

On Jan. 16, 70 startups, along with think-tank iSPIRT, wrote a letter to Modi saying they were in trouble because of the angel tax.

They were particularly concerned over the tax evaluation process, alleging that in many cases, the assessing officers disregard the discounted cash flow (DCF) method-based valuation report (as prescribed by law) and, instead, recalculate the valuation via the book-value method. The latter takes into account only the firm’s physical assets, which is unsuitable for technology startups with asset-light businesses.

In the letter to Modi, startups said:

Startups are in distress and many feel victimised mainly due to the subjectivity, cost, and arbitrariness involved in the implementation of this anti-evasionary measure which treats every assessee as guilty until proven innocent. The remedial measures available are not timely or viable for them. Some startups have even been forced to shut down due to it. Many have started moving out to more friendly regimes like Singapore. This process of justifying the valuation retrospectively to the satisfaction of the assessing officer has led to a negative sentiment among startups…

If the “angel tax” issue is not arrested immediately, then this will adversely affect the number of startups in India in the next three to four years and derail the entire Startup India movement.

The penalty for tax-evasion, along with the levy itself, can exceed over 100% of the funds raised, the foundation alleged. As a result, seed-investment in startups was down by 21% in 2018.

The (incomplete) solution

However, despite the government’s latest diktat in favour of the industry, not much is expected to change on the ground.

First, each time a company raises funds and requests an exemption, it is required to submit a slew of documents. Despite the recent changes, these applications will still be scrutinised by tax authorities. The angel-tax rules still require investors to upload income-tax returns, total assets, and net-worth certificates. Angel investors have been particularly wary of this provision.

“Why have minimum income criteria for an angel investor? Many professionals after retirement do angel investing and don’t have 50 lakhs of annual income. In so many cases the angels are non-resident Indians (NRIs) and don’t have an income of that lefvel in India,” Taparia told Quartz in reaction to the government’s latest notification.

Moreover, the recent changes announced by the government are applicable only to startups recognised by DIPP, where the amount of paid-up share capital and share premium do not exceed Rs10 crore.

“Limit of Rs10 crore as aggregate share premium is a limiting factor. It does not encourage corporate, family trust investments, etc in startups as most are not accredited investors,” Taparia said.

The new rules also do not take into consideration the startups registered before January 2012 for benefits. They continue to be outside the ambit of benefits because the DIPP system doesn’t allow back-dated registration of startups.

“The ask from startups remains intact: Exempt all 16,000+ DIPP level 1-recognised startups from section 56 2 (vii b), create a process through which all startups can submit 2-3 additional documents (financials, payroll, customer contracts, etc) that helps DIPP and CBDT understand that these are genuine startups and not shell companies,” Taparia said.

Moreover, the notification says nothing about the tax notices already received by startups.

According to a survey by LocalCircles, over 30% of startups received multiple tax notices in 2018. The latest clutch of tax notices for angel-tax evasion was sent out in December.