Is Angel Tax Relief a Boon for the Indian Startup Ecosystem? Suresh Prabhu, the Minister for Commerce and Industry, recently announced this relaxation broadening the definition of a startup by extending the tenure of existence from 7 to 10 years

A breeding ground for constant innovations, dedicated self-employment, and new entrepreneurial avenues, India ranks third in the list of largest startup ecosystems across the globe. The domain has been experiencing robust growth, with a NASSCOM report stating how the country retained its position as third in the list by adding 1200 new tech startups and experiencing a notable increase of investments in 2018. While these initiatives sound wonderful for the developing ecosystem, there are factors like lack of sustainability, shortage of funds and resources, heavy regulations during both inception and operation of an organization, and unavailability of affordable marketing channels, to name a few. Even potential investors and established entrepreneurs have to go through a laborious procedure, with heavy taxes levied on them before investing.

Moreover, startups had begun receiving income tax notices from the angel funding that they had received some years back. Angel investors also received several notices asking for details such as the source of income, bank account statements, and other financial data to be furnished. All of these issues have been plaguing the Indian startup ecosystem from the past few years, thereby hindering its development prospects.

To address this multitude of challenges, the government is relentlessly taking initiatives to bring about a positive shift. On February 19 this year, the Department for Promotion of Industry and Internal Trade (DPIIT) announced a series of changes broadening the definition of a "startup' and exempting investors and entrepreneurs from the supposed "angel tax'. An initiative that is projected to benefit over 7000 cash-starved startups struggling to continue their existence, this move by DPIIT has been welcomed by startups as well as venture capital funds, investors and entrepreneurs. As the startup ecosystem undergoes a transformation amidst such positive changes in regulations, here are the relaxations, exceptions, and the way forward:

Significant Changes Entailing the New Framework

In what previously triggered tax issues and chaos amidst the startup community, angel tax refers to the income tax payable on capital that was raised by unlisted organizations via the issue of shares wherein the share price was noted to be in excess of the fair market value (FMV) of shares sold. Introduced in the 2012-2013 Union Budget by the then Finance Minister Dr Pranab Mukherjee, this regulation was announced to combat the pressing issue of money-laundering. When angel tax was introduced, startups were defined as organizations that have been in existence for 7 years or less, with an annual turnover of INR 25 crores. The limit of funding exemption from angel tax was INR 10 crores then. All these regulations were very burdensome for the entire community, and all stakeholders in this ecosystem have continued to urge the government in reviewing these regulations.

Suresh Prabhu, the Minister for Commerce and Industry, recently announced this relaxation broadening the definition of a startup by extending the tenure of existence from 7 to 10 years, the annual turnover from INR 25 crores to INR 100 crores, and the limit that would make a company eligible to claim tax benefits from INR 10 crores to INR 25 crores. This move has been regarded as a welcome change by potential investors and affluent individuals who have now become keen on investing in startups without having to worry about the implications of the angel tax. Furthermore, investments made by non-resident Indians (NRIs), Alternate Investment Funds-Category I registered with SEBI, and listed Indian organizations with a net worth of a minimum of INR 100 crores or a turnover of at least INR 250 crores, will all be exempted from the angel tax in accordance with the newly-announced relaxation.

Additionally, the government has also simplified documentation and listing procedures for startups. Earlier, it was compulsory for startups to undergo a lengthy and complicated process in order to be approved from the inter-Ministerial Board along with the Central Board of Direct Taxes (CBDT). At present, only a declaration in Form 2 needs to be filed to claim angel tax benefits. Startups are also not required to show valuation reports or documentation supporting a higher valuation and share the premium anymore.

These changes will undoubtedly strengthen the very foundation of the Indian startup ecosystem, providing avenues for emerging and upcoming businesses to tap their true potential. Industry experts have estimated that this relaxation may help Indian startups raise a collective funding amount of approximately USD 12 billion by the end of this financial year, with as many as 2000 new investors onboard. As more and more affluent individuals with high net worth have begun considering angel investments, early-stage startups in the country are gradually paving their way towards endless opportunities.

Exceptions to this Relaxation of Norms

The regulations are set to bring about a radical change in the Indian startup community. However, there are certain exceptions to these norms. For instance, the eligibility for tax exemption will not be applied to those startups that invest the capital received from such an investment in land and buildings, loans and advances, contribution made to other entities, jewellery, artifacts, or any mode of transport where the actual cost exceeds INR 10 lakhs—if purchased or traded for purposes other than those regarding the business.

The Road Ahead

A welcome respite for the Indian startup ecosystem, the relaxation of angel tax regulations is the culmination of years of negotiations from the community and all other stakeholders. While the DPIIT has catered to most demands, a few concerns still need to be addressed. It is possible that the government may bring forth some more changes to cater to the ever-growing Indian startup ecosystem, which has kept the mood of the segment upbeat. With India remarkably ascending to 23rd rank from its previous 77th position in the World Bank's index of ease of doing business, the road certainly seems promising and prosperous ahead for investors, entrepreneurs and venture capital organizations to support innovative businesses in their growth journey.