Understanding Angel Tax and the Start-ups Story

Tax is like an eternal thing. Whether you look behind some 100 years and look now, you will see tax as a constant thing. And even if you could imagine the next 100 years, it will still be standing firmly behind you. Needless to mention that it will be there foreverand it is the next constant thing after change. Tax is collected in various forms and today in this article we will be talking about the Angel Tax. This type of tax was introduced back in 2012 as a step against money laundering.

 

For the newbies who are unaware of what this tax is, here’s the definition. Whenever a company gets funds from outside investors, the funds are considered as earnings and a tax of 30% is levied on it. Such a tax is called the Angel Tax in its simplest terms. Technically, it is the income tax payable on excess of amount received in lieu of shares over the fair market value of shares of the unlisted companies. Now, what makes it the hottest topic is that this tax is also need to be borne by the start-ups. Large established companies though difficult but still can afford paying this tax but when it comes to the infant start-ups, it is a pretty heavy load for them.

 

This tax is levied according to the section 56 (ii) of the Indian Income Tax Act. The fair market value of the company is decided by the tax officials themselves by the Net Asset Value method.Here is where the dispute arises. The fair market value is very subjective and arbitrary and a personwho may think a particular value of a company may not be thought similar by other person. These start-up organizations think that this is very unfair on their part as the FMV isdecided by the tax officials which usually they do not agree to. A solution to this is offered by the Discounted Cash Flow method of valuation. This widely accepted method discounts the future cash flows of the company to its present value. Though this method too has its own limitations, it gives a fair value to the start-up.

 

Last year in May2018, the Central Board of Direct Taxes(CBDT) issued a notice giving exemption to start-ups under section 56 of the act. To soothe the criesof the start-ups, the Department for Promotion of Industry and Internal Trade (DPIIT) has revised the definition to qualify an entity as a start-up. According to the amendment in the section, those entities incorporated for up to 10 years will be eligible for this exemption. Start-ups will be exempted from tax if the total investment including funding from the investors is within Rs. 10 crores. The upper limit for the turnover of exemption of such start-ups should be within Rs. 100 crores. Earlier, the start-ups needed to get approval from inter-ministerial board as an ‘innovative start-up’ along with certificate of valuation by a merchant banker. Now, theirapplications will be redirected to the DPIIT and evaluated by CBDT. The exemption will only be applicable if in the preceding 3 years, the investor had a minimum net worth of Rs. 2 crore or an average returned income of Rs. 25 lakhs.

 

There will be no exemption on the tax for those start-ups having gained investment in the following assets :

1. Land and building for any other purpose except office or business
2. Loans and advances which are not used in normal business operations
3. Capital contributions made to other entities
4. Motor vehicle or aircraft priced at more than Rs. 10 lakhs used for other purposes than for business.

 

However, this still has not solved the issues of those hundreds ofstart-ups which have received the notices from the tax offices. The tax authorities expect the start-up to share their investor details like bank statement, financial statements, and income tax returns. While these documents are highly confidential, thereoccurs conflict when these are not shared.

 

Consequently, the number of investors for start-ups has been constantly declining. This is followed by the amount of investments made which is also continuously witnessing fall.

 

In conclusion, at one side entrepreneurship is encouraged by the government but on the other side, a heavy tax levied holds back this encouragement.The start-ups already face issue of gaining investors at their early stages and when found one, the tax drags them down.This situation can be rightly called as feeding with desserts with sword holding by the neck. This again showed that entrepreneurship is not easy and smooth-running in India still today. Start-ups are a major source of new employment generation and despite this fact, the government still through its various ways counteractsthis ecosystem.