Following concerns raised by investors regarding angel tax notices sent to startups, Commerce and Industry Minister Suresh Prabhu said he has taken up the issue. “We have taken up the issue,” Prabhu replied in a tweet to chairman of Manipal Global Education T V Mohandas Pai, who had earlier tweeted: “Draconian Angel tax torturing start-ups: It’s killing genuine innovation.”
A top income tax department official said the “notices issued on angel tax to startups may be for those that are not recognised by the department of industrial policy and promotion (DIPP)”.
Several startups have raised concerns on taxation of angel funds under Section 56 of the Income Tax Act. Under the Section 56(2)(viib) of the Income-tax Act, companies with closely held shares, when issuing shares, are charged 30 per cent tax on the difference between funds raised as per the actual valuation and the fair-market value of the company. This is known as the angel tax.
The notices consider the value of funding received by startups, which is over and above the enterprise value, as ‘income from other sources’ and therefore, consider that as taxable.
In April, the government had tweaked the definition of startups to provide some relief wherein they were allowed to avail tax concession if total investment including funding from angel investors does not exceed Rs 10 crore. As per a notification by the Commerce and Industry Ministry, an angel investor picking up stakes in a startup should have a minimum net worth of Rs 2 crore or should have an average returned income of over Rs 25 lakh in the preceding three financial years.
Calculating ‘fair market value’ holds the key
Startups incorporated after 2016 and recognised under the Startup India policy are exempted from the levy of ‘angel’ tax. During the initial round of investment or angel funding, startups are often valued higher than what is considered the ‘fair market value’. The taxman uses traditional methods like discounted cash flows for gauging the correct value of a company, but investors and entrepreneurs say this method is outdated. The tax notices being faced by startups not recognised by DIPP or the ones incorporated before 2016, have created concerns among investors.
In February, the Central Board of Direct Taxes (CBDT) had directed income-tax commissioners not to take coercive measures against startups to recover the outstanding tax amount in case valuations have been modified or rejected by an assessing officer. The CBDT had also said that in all the cases that are pending with the Commissioner (Appeals), necessary administrative steps should be taken for expeditious disposal of appeals, “preferably by March 31, 2018”.
Startups can avail income tax benefit for three out of seven consecutive assessment years, but they have to approach an eight-member inter-ministerial board of certification for getting such concession.
A startup incorporated after April 1, 2016 but before April 1, 2021 is eligible for this tax incentive. As per the DIPP definition, startups set up as private limited company or limited liability partnership and incorporated after April 1, 2016, would be eligible for tax concessions and will have the status of startup up to seven years from the date of incorporation, or up to 10 years if it’s in the biotechnology sector. The company, however, loses the startup tag if its turnover in any year exceeds Rs 25 crore.
Tax experts said the angel tax provisions for startups need to be appropriately modified and provisions need to be reevaluated to cover all startups. Vikas Vasal, national leader – tax, Grant Thornton India LLP said, “The angel tax provisions need to be appropriately modified to carve out an exception for the startups or may be these cases should be referred to a panel before initiating any penal action to distinguish and protect genuine startups vis-a-vis tax avoidance schemes and arrangements. It’s not an easy task, however, to encourage entrepreneurship and employment in the country these provisions need to be reevaluated and softened a bit to cover all startups and not just the ones registered with the government.”