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Challenges for start-ups in India

Topics covered:

  1. Important aspects of governance, transparency and accountability, e-governance- applications, models, successes, limitations, and potential; citizens charters, transparency & accountability and institutional and other measures.
  2. Role of civil services in a democracy.
  3. Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.


Challenges for start-ups in India


What to study?

  • For Prelims: What is Angel tax?
  • For Mains: Challenges faced by start- ups in India and measures to address them.


Context: Citizens’ engagement forum LocalCircles has released a report on challenges faced by start- ups in India. The report is based on responses from over 15,000 start-ups, SMEs and entrepreneurs.


Challenge for start- ups:

  • Corruption
  • Bureaucratic inefficiencies.
  • Securing loans.
  • Funding


Angel tax:

Angel tax is one area that falls under corruption and bureaucratic inefficiencies as it takes the focus of entrepreneurs away from building a product or service to responding to tax notices and filing appeals, something that start-ups can clearly do without.

  • Angel tax continued to be a key pain point for start-ups, where the assessing officers in many cases reject the valuation method used by the start-up and instead treat the capital raised as income from other sources, thereby, raising a tax demand and penalty on the start-up.
  • Several start-ups and angel investors have raised concerns over notices received from the authorities related to taxation of angel funds. The Centre has set up a panel to look into the taxation issues faced by start-ups and angel investors.


What is 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.

The tax, under section 56(2)(viib), was introduced by in 2012 to fight money laundering. The stated rationale was that bribes and commissions could be disguised as angel investments to escape taxes. But given the possibility of this section being used to harass genuine startups, it was rarely invoked.


Why is Angel tax problematic?

There is no definitive or objective way to measure the ‘fair market value’ of a startup. Investors pay a premium for the idea and the business potential at the angel funding stage. However, tax officials seem to be assessing the value of the startups based on their net asset value at one point. Several startups say that they find it difficult to justify the higher valuation to tax officials.

In a notification dated May 24, 2018, the Central Board of Direct Taxes (CBDT) had exempted angel investors from the Angel Tax clause subject to fulfilment of certain terms and conditions, as specified by the Department of Industrial Policy and Promotion (DIPP). However, despite the exemption notification, there are a host of challenges that startups are still faced with, in order to get this exemption.


Sources: the hindu.

Mains Question: In view of some of the recent steps taken by the government, critically examine whether the government is micromanaging startups and e-commerce players?