Angel Tax Row: VC Funds Looking To Approach I-T Dept On Exemption List

Several venture capital (VC) funds backing Indian startups are reportedly planning to approach the Income Tax (I-T) Department as several investor-friendly jurisdictions such as Mauritius, Singapore, the Cayman Islands and the Netherlands have been excluded from the list of countries not attracting angel tax.

According to the Central Board of Direct Taxes (CBDT) notification on angel tax, sovereign wealth funds, pension funds and SEBI-registered portfolio investors from 21 countries and sovereignties are excluded from any angel tax charge.

While these included countries such as the US and Japan, where many major investors are headquartered, the so-called tax havens were missing from the list, where these VC firms set up their funds to avoid attracting angel tax on their Indian investments.

Since many active investors in India’s startup ecosystem have funds based out of these jurisdictions, the exclusion of Mauritius, Singapore and the Cayman Islands is of particular interest to VCs.

The angel tax is applied based on Section 56 (2) (VIIIb) of the Income Tax Act, as notified earlier this year. According to the provision, any difference between the fair market value and the face value of shares issued by a company is taxed.

According to the data from the Department of Promotion of Industry and Internal Trade (DPIIT), Mauritius, Singapore and the Cayman Islands are among the top 10 countries with the highest foreign direct investment (FDI) in India.

For instance, FDI inflow from Singapore stood at $13.08 Bn during April-December 2022, while Mauritius was $4.73 Bn during the same time. The FDI inflow also includes the amount invested in securities that don’t attract angel tax.

A VC cited by ET stated that the industry is set to reach out to CBDT to understand if there were additional protective measures that they can put in place to allow investments from Mauritius and Singapore to come into India without attracting angel tax.

The general industry sentiment is the worry that the current move will hurt the inflow of capital into the country, encourage the flipping of companies outside India and add more compliance burden on startups. Further, some investors believe that the government wants to widen its tax net by discouraging tax havens.

Shauraya Bhutani, cofounder of Capital Connect Advisors, told Inc42, “The exclusion of Singapore and Mauritius is certainly a surprise but perhaps, an interim mitigation technique by the authorities, as these jurisdictions are one of the major sources of capital inflow into Indian startups which also means they might need to be dealt with separately and on different terms than the current set of exempted countries, with the aim of balancing tax revenue and capital inflow.”

Bhutani added, “I expect to see a follow-up notification in the near future in regards to these jurisdictions but until then the capital inflow tap for Indian startups is open again, just not with the same pressure.”

Rajeev Suri, a managing partner at Orios Venture Partners, put down the move to the government’s intent to promote GIFT city as the preferred means to receive FDI. “We think such moves will continue to be implemented because they benefit the government in multiple ways, including in forex flows and in widening the income tax net,” Suri added.

Incidentally, the move from the I-T department comes as the likes of PhonePe have already moved their domicile to India, with the government itself planning to promote the reverse flipping of startups.

Razorpay is another startup considering shifting its domicile to India. However, the fintech unicorn is set to stare down a hefty tax bill; PhonePe parent Walmart had to pay INR 8,000 Cr to Indian authorities in retrospective tax before actually shifting to India.

The VC firms’ expected move also comes when the DPIIT has also taken up the issue with the Ministry of Finance.

Update | May 26, 2023, 8:30 AM

The story has been updated to include comments from Orios Venture Partners and Capital Connect Advisors.

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