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Why proposed change in Angel Tax has rattled Indian start-ups?

GS Paper 3

Syllabus: Indian Economy and issues relating to Planning, Mobilization of Resources

 

Source: IE

 Direction: The article focuses on angel investors and how concerned they are about the proposed changes to the angel tax.

  

Context: According to a proposal made in the Finance Bill, 2023, foreign/angel investors may be required to pay the “angel tax,” which was previously only supposed to be paid for investments raised by resident Indian investors.

 

Angel Investors
RolePros/Cons
●        Angel investors primarily provide capital for startups at early stages in exchange or convertible debt or equity ownership.

●        Angel investors often choose to get an accredited investor status (as per the SEBI AIF Regulations – an individual with a net worth of ₹7.5 crores/ whose annual income is ₹2 crores).

●        However, an accredited investor is not necessarily an angel investor.

●        To be an angel investor, they require having an interest in providing capital for startups.

Pros:

●        Less risk than taking out a small business loan

●        Angel investors typically have experience in investing

●        Mentorship, guidance and valuable insights for the startup

●        Research shows that angel investors’ supported startups are more likely to have substantial growth and give a higher rate of return.

Cons:

●        Loss of equity, loss of control in the business

●        Anticipate a high rate of return on their investment

 

 

What exactly is the proposed change?

  • The Finance Bill 2023, has proposed to amend Section 56(2) VII B of the Income Tax Act.
  • According to the clause (introduced in 2012 and commonly known as the ‘angel tax’), equity investments from residents for the issuance of shares at a price above their face value are treated as income for unlisted businesses like start-ups.
    • For instance, if a start-up share has a fair market value of Rs 10 per unit and is sold to an investor for Rs 20 during a subsequent funding round, the difference of Rs 10 would be taxable as income (at 30%).
    • By subscribing to shares of a closely held company at a price over the shares’ fair market value, it aims to prevent the creation and use of unaccounted money.
  • However, with the latest amendment, the government has proposed to also include foreign investors in the ambit.

 

Why are start-ups concerned?

  • According to a PwC India report, funding for India’s start-ups dropped by 33% to $24 billion in 2022 as compared to the previous year.
  • Foreign investors are a key source of funding for start-ups and have played a big role in increasing the valuation.
    • For instance, Tiger Global has invested in over a third of the start-ups that have turned unicorns (valuation of at least $1 billion).
  • The proposed amendment will accelerate flipping overseas, as foreign investors may not want to deal with additional tax liability.

 

Insta Links:

Angel Tax

  

Prelims Links: (UPSC 2014)

What does venture capital mean?

  1. Short-term capital provided to industries
  2. A long-term start-up capital provided to new entrepreneurs
  3. Funds provided to industries at times of incurring losses
  4. Funds provided for the replacement and renovation of industries

 

Ans: 2