Angel Tax Decoded
By Ninie Verma, Content Associate, 1stCheque by Favcy
- The alleged return of the scary 'Angel Tax' spooked investors and founders alike.
- So what exactly does Angel Tax mean, and do you and your startup need to worry about it?
Will the angel tax be the death knell for startup funding? This question was haunting the ecosystem earlier this month when the announcement of the tax's return caused big waves.
What is Angel Tax?
Coined "Angel Tax," the law is detailed in Section 56(2)(viib) of the Income Tax Act of 1961. This provision was added to the statute in 2012 to stop the roundtripping of black money through investments into unlisted companies at a significant premium. In essence, it is a special tax on capital gains that only applies to India.
Investments in private company entities are covered by the tax, however startups were excluded until 2016. New-age digital businesses came under scrutiny from the IT department as more and more of them began to raise venture capital. Investors frequently paid a premium in these fundraising transactions above the par value or fair market value of the securities, and as a result, the company was taxed on the additional revenue.
Therefore, Angel Tax is the tax that unlisted startups are required to pay on the capital they raise through the issue of shares. Naturally, it raised red flags throughout the ecosystem.
Startups were rattled because of the proposed changes in regulations in the Finance Bill through the amendments in Section 56(2) VII B of the Income Tax Act. Foreign investors are also proposed to be included in the ambit of taxation, wherein a startup raising funding from a foreign investor will also be liable to pay income tax if the funds are received above the face value of shares.
Cause for alarm? Barely...
The Angel Tax provision in the Finance Bill will not impact startups, Anurag Jain, secretary in the Department for Promotion of Industry and Internal Trade (DPIIT), reiterated on Tuesday (February 21).
“Let me put one thing very clearly. It does not affect startups in the least,” Jain said while addressing the PE-VC industry at the IVCA Conclave 2023 in Mumbai. “…there is a clear proviso which clearly brings out that it does not affect the startups.”
What’s truly being amended in the Finance Bill, 2023 is the exemption for overseas investors, which means any offshore fund investing in India will get impacted.
This includes some of the largest VC investors in India, including unicorn makers such as Tiger Global, Sequoia Capital, SoftBank, Accel, as well as early stage investors such as Y Combinator, AngelList and others.
Will it affect the funding scenario at a macro level? We don't think so. However, international VC funds are definitely subject to the tax. But with their bullishness on the early stage startup ecosystem in India, it remains to be seen if the tax truly drives them away.