Insights into Editorial: Timely review: On start-up tax

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Insights into Editorial: Timely review: On start-up tax


Context:

Centre decides to set up a five-member working committee to look into the angel tax issue and come up with guidelines.

Start-ups have come under the scrutiny of tax officials for having raised capital above the fair value of their shares. At least 80 start-ups have received notices to pay angel tax since last year.

So, by recommendations of this committee, Start-ups troubled by the so-called angel tax may soon receive some concession from the government.

 

What is ‘Angel Tax’?

The ‘angel tax’ is the tax on share premium paid to acquire new shares in a company that the tax authorities regard as excessive.

The Angel tax, which was first introduced in 2012 to curb money-laundering through the sale of shares of private unlisted companies at bloated prices, has caused a lot of anguish among start-up investors in the country.

It is a 30% tax that is levied on the funding received by start-ups from an external investor. However, this 30% tax is levied when start-ups receive angel funding at a valuation higher than its ‘fair market value’. It is counted as income to the company and is taxed.

Funds contributed by Angel Investors are known as Angel Funds. Angel Funds in India, are regulated by SEBI.

 

Issues with Angel Tax:

Start-up owners have complained that income tax officials have asked many start-ups to cough up money when they try to attract capital into their entities by issuing new shares.

On the other side, the IT department fears that start-ups may be used as convenient tools to launder illegally acquired money, so a tax on investments beyond a certain threshold is necessary to deter such shady operations.

But while the intent of such an angel tax may be justifiable, the arbitrary nature of it means the cost of unintended consequences could be larger than the supposed benefits.

 

Indian Income Tax Act, 1961:

In trying to curb money-laundering, Section 56(2)(viib) of the Indian Income Tax Act, 1961 gives income tax officials a free hand to harass even genuine start-ups looking to raise investments for their growth.

Under the Act, the IT department is free to arbitrarily decide the fair value of a company’s share and tax start-ups if the price at which their new shares are sold to investors is higher than the fair value of these shares.

The broad-brush tax on all investments means an unnecessary cost is imposed on the wider start-up community simply because of the lack of better means at the government’s disposal to tackle black money.

 

How Angel Tax Affects Start-ups and Angels investors:

Many unlisted and early-stage start-ups rely heavily on funding, the taxation will limit investors from putting their money and trust on fledgling and early-stage start-ups, which in effect stifles more people to come forward and start their own.

Angels investors have also received multiple notices asking them to furnish details on their source of income, their bank account statements and other financial data.

Income-tax officers claim that the scrutiny on start-ups is mainly due to concerns over money laundering

 

Clarification from CBDT:

CBDT clarifies that, it recognizes that start-ups are going to bring a lot of innovation to the country and, therefore, have to be supported in every possible manner.

The government had earlier eased the tax provision by building safeguards, although it could not ease the pain entirely.

The relaxations include exemption from share premium tax to start-ups notified by the government as well as to investments received from venture capital funds.

Therefore, recently, CBDT clarified that it is committed to promoting start-ups in the country.

Government has been promoting innovation and entrepreneurship under the Start-up India mission as these new-age companies have the potential to create jobs.

 

Conclusion:

The committee set up by the government will consider raising the threshold beyond which new investments into start-ups will be taxed.

It is expected that start-ups with aggregate paid-up share capital and share premium of less than ₹25 crore, against the previous threshold of only ₹10 crore, will not be taxed while attracting new investment.

This would definitely make life easier to a certain extent for angel investors and start-ups. But it will not address the real problem with the angel tax, which has to do with the unbridled power that it vests in the hands of the income tax authorities. It risks killing the nascent start-up ecosystem in the country.

Investors, foreign or domestic, may become wary of investing in new ideas when they are taxed while risking money on untested ventures.

So, the government should look to withdraw the angel tax and focus instead on building the capability to better identify and rein in illegal wealth.