The Angel Tax New Guidelines Should Provide a Clear and Fair Rebate Mechanism: Investors There is still a need for further reforms to create a more supportive environment for startups and angel investors in India, even though the new exemption guidelines have given startups and angel investors some relief by allowing the startups to claim exemption if their total investment does not exceed Rs 25 crore

Angel tax has long been a topic of discussion in India, having a big effect on both companies and angel investors. Due to the angel tax, startups, particularly those in the early stages, have found it extremely difficult to raise money. Startups now face a considerable financial burden due to the Angel Tax, which imposes a 30.9% tax on money obtained from angel investors.

"Owing to this, the investors are hesitant to invest in startups due to the high tax rate. Moreover, the burden of angel tax is particularly significant for startups that are not yet profitable and do not have significant revenue streams to support the tax payment," says Ashish Bhatia, Founder and CEO, India Accelerator which has more than 200 startups in its portfolio and invests about $100,000 to a million dollars in each startup as per the seed round.

"While for the angel investors, angel tax has made it less attractive to invest in startups. This has further reduced the flow of capital in the ecosystem, thereby hindering the growth of startups in the country," Bhatia adds.

Startups are asking the finance ministry to eliminate or at least raise the Rs 25 crore cut-off point below which they are free from the so-called angel tax. Only a limited portion of companies, according to the sector, will be able to reach this threshold.

The Centre is compiling feedback from many stakeholders and anticipates releasing a comprehensive explanation of angel tax in the coming days.

According to Dr Somdutta Singh, Founder and CEO of a cross-border e-commerce accelerator Assiduus Global that employs AI technology to assist 60+ Fortune 500 companies and enterprises in generating over $300 million in GMV for their clients, the new guidelines should provide investors with a clear and fair rebate mechanism, as it can be the catalyst for unleashing the true potential of India's startup ecosystem.

"By removing the fear of taxation, investors can confidently back startups that have the potential to create innovative solutions that can impact global economies. In turn, startups can focus on what they do best: innovate, create, and transform," she says.

At a meeting last week with the finance ministry and the Department for Promotion of Industry and Internal Trade (DPIIT), startups brought up these and other issues. In addition, they voiced their opposition to the plan to apply the angel tax to overseas investors.

"There is a significant influx of domestic and foreign capital in the startup ecosystem. Startups on an average have started raising larger capital and the Rs 25 crore threshold limit would certainly need to be raised considering the current ecosystem we are into. Especially amidst the funding winter, the measures need to be proactive by the Finance Ministry in order to set a positive outlook to the Foreign Capital flowing in," highlights Umesh Uttamchandani, Co-founder, DevX Venture Fund, which invests in tech enabled early stage startups in Seed to Pre-Series A deals with the participation of up to $250,000.

"Out of the $25 billion funds raised in 2022, growth and late stage deals comprise 88% of the inflow and with a threshold limit in place, good capital gets taxed heavily which needs to be modified as investors might just prefer to invest in ecosystems which promise better returns and are tax friendly," Uttamchandani says.

According to those with knowledge of the discussions, the industry has also sought flexibility to invest excess cash in liquid assets and the money market.

If a closely held firm issues shares at a price above fair market value, calculated using the authorised methodology, the difference is to be taxed as income from other sources under Section 56(2)(vii)(b) of the Income Tax Act.

When the startup's total paid-up share capital and share premium after the issuance of shares does not exceed Rs 25 crore, this tax is not assessed. The most recent change to this barrier was a rise from Rs 10 crore in 2019.

The clause, known as the "angel tax," was implemented as an anti-evasion mechanism to stop money laundering through exaggerated valuations, but it has had an impact on startup and angel investments.

As long as total investment, including backing from angel investors, does not exceed Rs 25 crore, startups registered with DPIIT are exempt from the rule.

The sector claims that the threshold is too low because of rising input costs and wage inflation. According to them, the cap discourages startups from registering with DPIIT.

The representation stated, "Given the fundamental nature of startups, there is a need for continuous investment towards innovation and improvisation of products/processes." Additionally, expanding operations to include all of India or the world would require large sums of money to put up the logistics infrastructure.

Shares issued by non-residents, venture capital firms registered as category I alternate investment funds (AIFs), and specific enterprises were not subject to the Rs 25 crore threshold.

This exemption was eliminated by the Finance Bill 2023, which also intends to include international investors in the scope of the angel tax, which up until this point has only applied to Indian citizens and funds that were not registered as AIFs.

"To garner "Make in India" and building in India for India initiatives, it is imperative that the tax regime is friendly for stakeholders," states Neha Khanna, Director, ValPro and Enablers. The platform 'Enablers', launched by financial services firm ValPro, enables and assists entrepreneurs to connect and raise funds from investors.

"The startup ecosystem has witnessed a sea change with non-AIFs becoming the main source of angel and seed capital in the country. The angel tax acts as a deterrent for this class of investors who are the first step towards larger milestones for the startup ecosystem. Further, the possible inclusion of non-residents will also be seen in a negative light as foreign institutions allocate capital to India. Capital drain becomes a cause of concern if startups are compelled to switch structures to other countries for foreign investors," she adds further.

Since foreign investment continues to be a significant source of capital, the startup ecosystem and investors have expressed worry.