The contentious “Angel Tax’ is set to be on its way out. That’s one of the recommendations made by the Ministry of Commerce to the Ministry of Finance in the run up to the upcoming Budget 2024.
R.K. Singh, Secretary with the Department of Promotion of Industry and Internal Trade or DPIIT, has said and I quote:
“Based on consultations with startups, we have recommended the removal of the Angel Tax. The decision is to be taken by the Ministry of Finance; we have provided our inputs.: Unquote.
Industry watchers are of the belief that this move is likely to bring considerable relief to both early stage startups and their investors.
How?
Let’s first take a look at what the ‘Angel Tax’ really is.
Angel Tax is simply an Income Tax levied at the rate of 30.6% when an unlisted company issues shares to an investor at a price higher than its fair market value.
That brings us to the question: How does one calculate the fair market value of a company?
The sum total of the market value of all the tangible and intangible assets held by a startup or closely held company is its fair market value.
Therefore, when an unlisted startup gets equity investments from residents of India for issue of shares that exceed their face value, the excess amount is subject to income tax at the rate of 30.6%, under the heading: ‘Income from other sources’ for that particular financial year.
So, why was the angel tax introduced in the first place?
It was introduced in 2012 in order to deter the generation and use of unaccounted money through the subscription of shares of a closely held company.
Sounds fair.
Why has it now become an impediment for startups?
To understand that lets look at the phrase: ‘fair market value’.
The angel tax becomes an additional liability on startups receiving investments above their company’s fair market value. The investment are really the lifelines of early stage ones grappling with consistent funding for survival in highly competitive marketplaces and business environments. Startups, by definition, are required to cover a huge distance in their break-even journeys in a very short period of time.
Constant funding when money is being spent on market capture and customer acquisition become a matter of life and death for startups. An additional burden of 30.6% only makes things worse in an overly cut-throat competitive marketplace.
If things were not bad enough, in 2023, this tax was extended to investments from non-residents as well.
Some relief was provided by the government in 2019, with an exemption from this angel tax, so long as the turnover of the startup was over Rs 100 crore, and the paid-up capital and share premium did not exceed Rs 25 crores.
Businesses take time to hit the Rs 100 crore turnover target...and that means the exemption failed to provide much relief to most entrepreneurs struggling with their early stage startup ventures
With unicorns drying up—there have been just three new ones in 2024 so far—the removal of the angel tax could just be the game changer the startup ecosystem has been waiting for.
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