Venture Capital Body Submits its Angel Tax Proposal To Govt.

Dated- 14/01/2019

Source- Economics times

Angel tax- Angel Tax is a 30% tax that is levied on the funding received by startups from an external
investor. However, this 30% tax is levied when startups receive angel funding at a valuation higher than
its ‘fair market value’. It is counted as income to the company and is taxed. Angel tax was introduced in
2012, with the purpose of keeping money laundering in check.

The Problem – The startups were particularly concerned over the tax evaluation process, alleging that
in many cases, the assessing officers disregard the discounted cash flow (DCF) method-based valuation
report (as prescribed by law) and, instead, recalculate the valuation via the book-value method. The latter
takes into account only the firm’s physical assets, which is unsuitable for technology startups with asset-
light businesses.

Income Tax notices- One of the reasons put forward by the Income Tax Department to send such
notices is to get information for distinguishing the genuine startups from the bogus ones.
The notices essentially fall under two brackets: Notices under section 56(2)(viib) of the Income Tax Act,
which is called income from other sources. This section states that any excess consideration received by a
company will be treated as its income if it issues shares to a resident at a price which exceeds the fair
market value of the shares. The section is invalid if consideration is received from venture capital
companies, venture capital funds or a class of persons notified by the government.

Notices under section 142(1) of the I-T Act. An assessing officer sends a notice under this section to
procure additional documents needed to carry out a scrutiny assessment. The assessing officer has to
complete an assessment within 21 months of the end of the assessment year or 33 months of the end of
the financial year.

The Government’s stand - Earlier in the year, the Department of Revenue (DoR) had issued a
notification directing assessing officers not to take coercive steps on recovery of angel tax against
registered start-ups. But unregistered startups that have already raised angel investment may still be under
the scanner of the income tax authorities.

On Thursday, the CBDT issued a statement that no coercive action related to tax recovery would be taken
till an expert panel resolves this issue. “CBDT recognizes that startups are going to bring a lot of
innovation to the country and, therefore, have to be supported in every possible manner,” the
CBDT statement said.

A panel of eminent experts from IITs and IIMs will be formed soon to prepare a new framework for
recognition of startups.

Solution by Indian Private Equity & Venture Capital Association (IVCA)- The IVCA
has submitted a Three step proposal to CBDT and the department of Industrial Policy and Promotion Last
week to resolve the angel tax issue that has emerged as a huge roadblock for many Indian startups
  To exempt all registered startups up to ₹10 crore of total non-promoter capital raised
 The proposal has also added that HNI investments if made along with an exempted investor or a
verified fund such as Alternative Investment Fund (AIF I) venture capital fund should also be
excused from such notices.
 The proposal also suggested that registered startups which have PAN numbers of all its
shareholders should also be exempted.

Impact - At present, the angel tax rate stands at a whopping 30 percent, which according to Nasscom
has resulted in a 53 percent drop in angel funding during the last half of 2018. If the angel tax is not
exempted it will be a factor which will lead to pulling down angel investment in country. In the quarter
ending September for instance, venture capital investments in startups in India declined by over 25
percent from a year ago. The amount slid to USD 275 million in 78 deals from last year’s USD 309
million in 104 investments, according to a report by research firm Venture Intelligence. “Some reports
suggest a 30 percent drop in startup and Series A investments in 2019.If it is not abolished or at least
exempted it will result in less innovation in the country resulting it into lower GDP and also the Make-In-
India dream will be in doldrums.