Angel tax, under Section 56(2)(viib) of the Income Tax act, has spooked numerous investors and startups alike since its introduction in 2012. But this year’s budget relieves Indian startups a little. In her address of Budget 2019, Finance Minister Nirmala Sitharaman announced that startups under Angel Tax, who have submitted all relevant documents and declarations will not be subject to any scrutiny from the IT department.
Angel Tax is 30% tax that is levied on the funding received by startups from a angel investor i.e. an external investor. But this tax is levied only when startups receive angel funding at a valuation which is higher than its Fair Market Price (FMV). Startups of firms with governments or those who raise money from recognized venture capital funds are exempted from this particular tax. VCs that invest via that route are categorised under Category 1 AIFs.
Earlier, startups had to explain their firm’s valuation to tax assessing officers and had to get necessary financial documents from their angel investors. This engagement between a startup and a tax assessing officer were complicated and often discouraged new startups from going out to raise angel funds. Angel fund, without a doubt, is perhaps the most crucial capital raising exercise a startup does in its lifecycle.
To deal with this, the government has niw proposed an e-verification process to skip this engagement between a startup and tax inspectors altogether. Startups and investors will be able to secure the filings through this mechanism without having to explain anything to a tax investor.
Sitharaman also said that special arrangements will be made by Central Board of Direct Taxes (CBDT) for pending assessments and grievances of startups. She said, “It will be ensured that no scrutiny be carried out in such cases by the assessing officer without obtaining approval of supervisory officer.”
Another great announcement is for startups, who are funded by investors under Category 2 AIF. These startups will now be exempted from Angel Tax. “At present startups are not required to justify shared market value of their shares issues to certain investors including category 1 AIF. I propose to extend this benefit to category 2 AIF also. Therefore, the valuation of shares issued to these funds will be beyond the scope of IT scrutiny,” Sitharaman added.
Angel Tax was introduced to fight against money laundering which included bribes under the name of angel investments to evade taxes. But it ended up harassing new startups even when “Make In India” and “Startup India” programs were at their peak. Now, this year’s budget has finally offered respite to these startups.