Income Tax Dept. Stays Recovery Proceedings Of Angel Tax; Gives Startups A Breath of Fresh Air

As an added relief for startups, the Income Tax department has stayed the recovery proceedings of angel tax levied on companies that are recognised as startups by the Department of Policy and Promotion (DIPP).

The development comes just a day after the DIPP extended tax exemptions to startups founded before 2016 and with up to $1.56 Mn (INR 10 Cr) in angel funding.

As part of a notification released yesterday, the Department of Revenue under the Ministry of Finance instructed assessing officers not to take any “coercive measure to recover the outstanding demand” of startups that have raised angel investments at high valuations, provided these companies are identified by the DIPP as startups.

Additionally, the notification has directed the concerned authorities for speedy disposal of pending appeals no later than March 31, 2018.

Till date, the IT department has reportedly sent notices to 30 angel investor-backed startups.

Introduced by former Finance Minister Pranab Mukherjee under the Finance Act 2012, angel tax is applicable on the capital raised by unlisted companies from any individual against an issue of shares in excess of the fair market value. The tax has been classified as ‘income from other sources’ under Section 56 (II) of the Income Tax Act of India.

In 2012, the tax was 30.9% of the total funding applicable to mature private companies as well as small startups raising early-stage investments from Indian residents.

In 2015, amid growing protests from Indian startups, entrepreneurs and investors, the Centre proposed an amendment to exempt angel tax on investments not exceeding $1.56 Mn (INR 10 Cr). In 2016, the Central Board of Direct Taxes (CBDT) issued circulars to exempt startups from angel taxes, even if the funding raised by a startup was in excess of fair market value.

On paper, though the reforms looked decent, owing to the centre’s limited understanding and definition of startups, most of the startups still had to pay angel taxes as most were not officially recognised as startups.

According to the DIPP norms, to be identified as a startup, a company must not be more than seven years old (previously five years) and must have an annual turnover that does not exceed $3.9 Mn (INR 25 Cr).

Government Finally Taking Steps To Resolve The Angel Tax Fiasco

During this year’s budget session, Finance Minister Arun Jaitley announced that additional measures would be taken to strengthen the environment for venture capital funds and for their growth and successful operation of alternative investment funds in the country.

Earlier this week, the DIPP announced that startups founded before 2016 and with up to $1.56 Mn in angel funding will now be eligible for exemptions on angel tax. Confirming the development, an official from the department said, “We have finalised the conditions which will resolve the issue of pre-2016 startups.”

According to reports, this move will benefit about 300 startups that received funding from the Angel Investors Network.

Recently, Finance Secretary Hasmukh Adhia gave his assurance on the matter, stating that only investors in unlisted companies were being brought under the scanner as the transactions might not be genuine or might even be a front for money laundering.

He said, “We will protect genuine investors in start-ups. We are not asking questions from venture capitalists or non-resident investors who have invested in startups. Those startups registered with the department of industrial policy and promotion are also not under the scanner.”

Along the same lines, Sushil Chandra, Chairman of the Central Board of Direct Taxes (CBDT) earlier argued that the Income Tax department was mostly looking at startups that have raised angel funding at highly inflated valuations. However, Chandra claimed the IT department will wait until the first appeal is decided before initiating the recovery process.

Angel tax has been a controversial topic among startups since its introduction in 2012. Given that India is currently the third largest startup ecosystem in the world, the government must ensure that startups in the country are offered adequate support to succeed. The latest decision by the Income Tax department to stay all recovery proceedings of angel tax is a step in the right direction.

(The development was reported by Livemint)