Angel Tax Returns – Devil For Startups?

Angel Tax

The Angel Tax of 2012 has risen from the ashes and is now haunting startups. Let’s see how it will impact the startup ecosystem.

We have all seen the glory of startups that started small but have made their way towards sky-high valuations. But, apart from all of us, the government has also been tracking the exponential achievement of startups since 2012! And after looking at the achievement, they bought startups a gift called the angel tax. The twist here is that it’s not really a gift for startups but for the government. 

To quickly give you a gist. An angel tax is a tax that startups must pay when they raise funding at a valuation higher than the fair market valuation. 

And during this Union Budget 2023, the heavenly-sounding tax became a devilish burden for startups and investors.

The Story

The story began back in 2012 when black money was a concern for the government. They suspected that turning black money into white was an easy job. Investors could easily invest their black money into unlisted shell companies at high valuations. 

So, the government proposed to tax any investment into an unlisted company if it was made at a higher valuation than the fair market value. And the interesting part is that this tax could go as high as 20% to 30% of the invested capital. 

After the provision came into effect, it did reduce money laundering. But, in 2017 and 2018, when the startup market exploded, they experienced a setback in raising capital from Angel investors because of this tax. 

Just imagine this situation – A few young and determined partners are trying to bring their idea to life. Despite pitching their concept to numerous Angel investors, luck wasn’t on their side. Finally, they manage to impress an angel investor to fund their startup, only to have almost 30% of the funds snatched away by the government in the form of the dreaded Angel Tax.

The government soon realised that if this continued, it would sabotage growth. And then came the resolution. 

Change in Rules of Angel Tax

In 2019, the government suggested a tax exemption on Angel tax under some conditions. This exemption applied to startups that had not yet completed ten years of operation, had a turnover of less than Rs 100 crore and had a paid-up share capital of no more than Rs 25 crore. 

This, indeed, was a relief for the early-stage startup ecosystem. 

Changes in Budget 2023

Everything was going well until the Finance Minister Nirmala Sitharaman proposed changes in the rules for Angel Tax in the recent budget. 

The proposal stated that when an Indian unlisted company sells its shares to a foreign investor at a premium, it would be treated as income from other sources and would be taxed. However, according to Business Standard, startups registered with the Department of Promotion of Industry and Internal Trade (DPIIT) are exempt from the angel tax.

But remember issuing shares at high valuations over fair value is not forgiven!

This amendment will come into effect from April 1, 2023. 

What’s Next?

The funding winter has already gripped the startup ecosystem. With the proposed changes in the Budget, raising funds could become even more difficult for the startup ecosystem as foreign investors would be concerned about the tax liability that the angel tax attracts. 

What could happen is just as Finance Minister stated in the economic survey regarding the ‘flipping of startups’. Flipping basically means that an Indian startup transfers the company into a fully owned subsidiary of a foreign entity.

Yes, well-established startups could flip to friendlier shores. But what about early-stage startups who are seeking growth and high valuations? The question remains unanswered. 

That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!

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