"Angel tax" is a term commonly used in India to refer to the tax that may be levied on the funding received by startups from angel investors. Angel investors are individuals or groups who provide capital to early-stage startups in exchange for equity or convertible debt.
The term "angel tax" gained attention due to certain provisions in the Indian Income Tax Act that could potentially tax the capital raised by startups from angel investors as income, even if the investment was made at a premium to the fair market value of the startup's shares.
Moreover, it is levied when an unlisted company issues shares to an investor at a price higher than its fair market value. Earlier, it was imposed only on investments made by a resident investor. However, the Finance Act 2023 proposed to extend angel tax even to non-residents.
In India, under the Income Tax Act, if a startup received funding from an Indian investor at a price higher than the fair market value of the shares, the excess amount was considered as income and taxed as such.
This was often problematic for startups since they typically receive investments at higher valuations compared to their actual book value.
The controversy surrounding the angel tax arose from the arbitrary nature of its application. Many startups, especially those in their early stages, were subject to extensive tax scrutiny, and there were cases of tax authorities imposing taxes on investments that were genuine. This led to concerns within the startup ecosystem that it could stifle entrepreneurship and investment.
The government introduced the angel tax to curb money laundering and make it easier for businesses to comply with tax norms but startups have certain issues with the angel tax surrounding a number of factors from funding to getting finance for restructuring of expansion plan.
Since startups frequently lack tangible assets many businesses go to angel investors who see their potential and offer financial support in return for equity. But, if the investment exceeds the fair market value, it is regarded as ‘income from other sources’, which attracts angel tax. This can make it tough for new companies to implement their expansion policies.
High net-worth individuals and angel investors can be unwilling to invest in startups due to the angel tax. This can result in the scarcity of funds for many entrepreneurs.
Even after many amendments since its inception in 2012, the angel tax still remains a menace to Indian startups.
To ease the condition, recently, the Central Board of Direct Taxes (CBDT) has directed its officers to not carry out any scrutiny of angel tax provisions for startups recognized by the Department for Promotion of Industry and Internet Trade.
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