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Startup founders, investors spot devils in the details of new angel tax norms

Startup founders, investors spot devils in the details of new angel tax norms
Bhakti Nair/VCCircle

On Wednesday, the commerce and industry ministry issued a notification that sought to address the contentious ‘angel tax’ that has been a thorn in the side of startups and angel investors for nearly eight years. While the notification solves some problems, notably easing the process of seeking exemptions, the broad consensus is that startups remain as vulnerable as before to notices from the income tax department.

“The new norms don’t solve a lot of the fundamental issues,” Abey Zacharia, co-founder and CEO of mobile commerce platform Goodbox, told TechCircle. Goodbox was among the 68 startups that had written to the Prime Minister’s Office (PMO) seeking a solution to the angel tax issue. “The problem needs to be viewed at a holistic level, and needs structural changes,” he added.

Goodbox and its peers sought the PMO’s intervention after a number of early-stage ventures were slapped with tax notices over funds raised from ‘unaccredited’ angel investors, chiefly friends, family or angel investors not registered with the markets regulator. Section 56 (2) (vii b) of the Income Tax Act taxes angel investments in startups at 30%, charged as ‘income from other sources’.

Taking away positives

The new notification, effective immediately, does away with the certification that startups had to obtain earlier from an inter-ministerial board under the Department of Industrial Policy and Promotion (DIPP). The board used to meet only once in three to four weeks for tax relief.

Instead, startups can apply to the DIPP with necessary documents including annual accounts for the last three financial years or since the date of incorporation and a copy of the income tax returns for the last three years. The DIPP will in turn pass on the applications to the Central Bureau of Direct Taxes (CBDT) which will have to approve or reject the application within 45 days of its receipt. The notification applies to companies where the paid-up share capital and premium on shares does not exceed Rs 10 crore.

“It has simplified the earlier process of IMB (inter-ministerial board)... it’s a sure step in the right direction,” said Padmaja Ruparel, co-founder and president of Indian Angel Network. In fact, the redressal process may not even take as long as 45 days, said Dipankar Bandyopadhyay, partner at law firm Verus, which has offices in Mumbai, Delhi & Kolkata. “The approval procedure is more about assessing the rationale or intent behind the valuation put up by the startup concerned,” he said.

Some of the other positives include requiring investors to directly upload net worth details and income tax returns on to the DIPP portal. This task was fulfilled by the startup founder until now. Also, startups are now exempt from obtaining a merchant bankers certificate for specifying the fair market value of shares.

“This was a cumbersome process,” said Atul Pandey, partner at legal firm Khaitan & Co. “The income tax department and startups differ on how the net worth of such startups are to be calculated. By ensuring that fewer documents are uploaded on the DIPP portal, it has certainly made the process simpler,” he said.

“The exemption from obtaining a merchant banker's certificate will save a lot of money for small startups,” said Bandyopadhyay.

Many sceptics

Despite the positives outlined, a number of stakeholders are of the view that the new norms will actually complicate matters rather than address existing problems.

Two issues, in particular, have triggered dismay. One is the hike in annual income limit as a requisite to be an angel investor. Earlier, angel investors needed to have an annual income of Rs 25 lakh with a net worth of Rs 2 crore. The new norms, while leaving the net-worth part untouched, have hiked the annual income limit to Rs 50 lakh.

Stakeholders feel that this might reduce the number of angel investors. Of the total number of assessees who filed income tax returns last year, only around 1.5 lakh assessees mentioned an annual income of more than Rs 50 lakh, according to Shreejith Moolayil, co-founder of Pune-based health food startup True Elements. Goodbox’s Zachariah said that while the angel networks and individual angels who fall under the high net worth individuals (HNI) category might qualify, friends and families who put in money are not likely to qualify.

Thousands of startups which have received notifications will not get any relief, he added.

The other issue of primary concern was that the new notification has clearly mentioned the revised angel tax exemption norms do not apply to startups that have received tax notices in the past.

Going by media reports, thousands of startups have received notices both from the Ministry of Corporate Affairs and the country’s tax authorities in the past over valuations and payment of tax dues.

In the absence of any further favourable clarifications or iterations from DIPP or CBDT, these startups risk having their accounts frozen, which could eventually force them to shut down.

Even the 45-day time limit given to the CBDT to process applications has come up for criticism. “By making the process timebound, it is expected that it might speed things up. However, in the absence of a deeming provision wherein automatic approval will be granted in case no approval is obtained within 45 days, the actual benefit of this provision is doubtful,” said Khaitan’s Pandey.

Zachariah argued that a 45-day delay could even scuttle  potential investments.
 
Others have taken an even more pessimistic view by labelling the new notification as patchwork arrived out of a phased approach.
 
Way Forward

The concept of angel tax was first introduced in the 2012 budget to fix a loophole that enabled money laundering by investors who put in money before taking it out at a high premium.  Many stakeholders say the best way forward is to revert to the pre-angel tax era. However, this might be easier said than done.

“Section 56(2)(viib) is a general anti-abuse provision which applies even to companies which are not startups,” said Verus’ Bandyopadhyay. “Anti-abuse provisions cannot be eliminated altogether but user friendly exemption or advance ruling mechanism (like the current notification) will help to mitigate confusion around their application.” 

Khaitan’s Pandey said that while there may be a considerable number of startups who have legitimate grievances, there will also be cases wherein the fair value of companies has been artificially inflated.

“Given this perspective, removal of angel tax will face a strong pushback from tax authorities,” Pandey added.

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