ANGEL TAX: A Nightmare for Startups

Last Updated On: Feb. 15, 2020, 3:06 p.m.

All in all, what is Angel Tax? 

Angel Tax is a 30% tax that is levied on the funding received by startups from an external investor. In any case, this 30% tax is connected when new organizations get angel financing at a valuation higher than their "fair market value". India introduced its angel tax provision in 2012, amid concerns that wealthy individuals could invest in bogus start-ups as a way to launder money. But entrepreneurs say the tax code provision is being misused and could stifle their companies.


There is no clear or target approach to gauge the "fair market value" of another organization. Speculators income a premium for the thought and business potential in the Angel financing stage. Nonetheless, impose authorities appear to assess the estimation of new organizations dependent on their net asset value at one point . A few new organizations guarantee that they think that its hard to legitimize the most elevated valuation of tax authorities. 


In a notice dated May 24, 2018, the Central Direct Tax Board (CBDT) had exempted heavenly attendant speculators from the Angel Tax statement, subject to consistency with specific terms and conditions, as what is indicated by the Department of Industrial Policy and Promotion  (DIPP). In any case, regardless of the exclusion notice, there are various difficulties that new companies still face to get this exception. 


Angel Tax was, therefore, problematic for a few reasons. For one, valuing startups based on their assets alone, given intangibles such as goodwill is not easy. Nor is it easy to arrive at a ‘fair value’ for them, based on discounted cash flows. So, startups are often valued subjectively and the valuation which seems sky-high to some, may be fair to others.


Some startups have even got tax demands because their companies have become lessvaluable. To understand this bizarre situation, imagine a company that has raised money in two rounds. In the first round, it raised Rs. 1 crore by selling 10% stake. After that, business conditions worsened, and competition increased. Now, when it tried to raise money again, it had to give up 12.5% stake for the same Rs. 1 crore (because its valuation had fallen). In other words, in Round 1, the company got Rs. 10 lakh for each 1% stake it sold, while in Round 2, it got only Rs. 8 lakh for the same amount of shares.


Now the IT department decides to treat the valuation of Round 2 as 'fair market price' and assesses that the company should have received only Rs. 80 lakh for the 10% stake it sold in Round 1, instead of the Rs. 1 crore it got. The Rs. 20 lakh difference would be treated as taxable income. And, because, in the IT department's view, that tax ought to have been paid during Round 1, a fine would also be levied on the company. Imagine the startup's plight if it is asked to cough up Rs. 10 lakh in prior taxes and fines right at a time when its valuation has gone down in the market.


Another set of notices have gone out under section 142(1). This section empowers tax officials to ask for the tax returns, creditworthiness, bank details and correspondence of angel investors who have put money in a startup. On the face of it, this section is meant to separate money launderers from genuine angel investors. However, the sudden demand for additional documents increases compliance costs for startups, who are usually struggling with finance and time.

Startups have been asked to register with the Department of Industrial Policy & Promotion (DIPP) to avoid getting such tax demands. However, only those companies which are less than seven years old, have never had an annual turnover of more than Rs. 25 crore and did not get more than 10 crores in total from angel investors qualify as startups. This means that startups who have done well in any one year in the past seven are automatically disqualified. Media reports suggest even startups who are registered with DIPP have received notices.


Startups enjoy income tax benefits for three out of seven consecutive assessment years. They have to apply to an eight-member, inter-ministerial board of certification to avail of the concession. An angel investor funds a startup during the nascent stages. Typically, about 300-400 startups get angel funding in a year in the country. 


In nutshell, the provision of leving Angel Tax to the Startups aspirant of contributing to the growth if Country shall be reexamined to balance the interests of genuine startups and also that of revenue otherwise the Startups will shut down their business in the worst situations.



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