Indian startups’ vexing angel tax problem may just be resolved within a week

…and hope for the best.
…and hope for the best.
Image: AP Photo/Altaf Qadri
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India’s startup community, which has for months been lobbying for relief from the country’s vexing angel tax, may soon get some reprieve.

On Feb. 04, Ramesh Abhishek, secretary at the Department for Promotion of Industry and Internal Trade, said the department was committed to resolving Indian startups’ biggest taxation woe. Abhishek assured a clutch of entrepreneurs and investors that his team “will form a small working group and try to come out with some suggestions and solutions in the next four-five days.”

The meeting in New Delhi was attended by around 30 representatives from the Indian startup industry, an entrepreneur who was at the gathering told Quartz.

The startup community has for long been on a collision course with the taxman over the latter’s angel tax notices. The tax is triggered when a startup raises equity funding in excess of its “fair valuation.” The premium paid by the investors is currently treated as income for the startups, and attracts an over 30% tax.

Over 70% respondents in a recent survey of 2,500 Indian startups said they had received at least one angel tax notice, while almost 30% said they had received three or more.

Why tax angels?

Angel tax was introduced in Section 56 of the Income Tax Act in the union budget for 2012. The motivation for the tax was to curb money laundering via small companies.

However, the levy has become extremely problematic for startups. Several of them have been slapped with hefty penalties for late payment of angel tax, which sometimes exceeds the very fundraising that is being taxed.

Additionally, fearing tax liabilities, angel investments in the country have declined significantly. During January-June 2018, early-stage funding in Indian startups fell to $137.8 million (around Rs986 crore) from $200 million a year ago, according to the startup data platform Tracxn.

Also, in 2018, there were just 870 seed investment rounds—a 22% fall from the previous year.

“Through these measures (angel tax), we are penalising the non-culpable majority in order to keep the minority of wrongdoers in check,” said Sharan Grandigae, founder and CEO of four-year-old user experience (UX) design agency, Redd Experience Design. “When we have laws that hold organisations responsible for malpractice, what’s the additional need for registrations and licences and taxes? A fundamental shift in our permission-led thinking is required today if we are to grow larger as an economy.”

What to expect?

While the Indian startup community has been lobbying for a complete exemption from angel tax, Abhishek blankly ruled out the possibility of any such move by the government in his meeting with entrepreneurs.

“They won’t scrap Section 56 because money laundering is a major problem. But they are willing to work out a solution,” another entrepreneur present at the meeting told Quartz, requesting anonymity. “We have suggested that the tax department can ask for specific documents from startups that prove there’s nothing unlawful being done with the investments they receive. These documents can be anything from a startups’ monthly expenditure report to goods and services tax (GST) filings or even financials.”

However, the government may announce some additional sops that could help startups. Some such measures discussed in the Feb. 04 meeting include:

  • Currently, startups can apply for an exemption from angel tax if their paid-up share capital is below Rs10 crore. Raising this ceiling to Rs25 crore could be considered.
  • The minimum income criteria for an investor may be lowered to Rs25 lakh from the current Rs50 lakh.
  • The minimum net worth criteria for an investor could be brought down to Rs1 crore from the existing Rs2 crore.

Whether these measures can resolve the tangle remains a moot question.