SUMMARY
Foreign investments into Indian startups may be impacted as a result of the new provision of Angel Tax
Startups long-pending demands of overhauling IMB certifications stand unaddressed in the Union Budget 2023-24
ESOPS tax deferment concerns receive no mention in FM’s Budget Speech
Foreign venture capital investments into Indian startups are likely to face additional tax burden under the new amendments of Section 56 (2) of the IT Act, or Angel Tax. This comes at a time when the startup ecosystem is reeling under the funding crunch, valuations slump in the face of global macroeconomic headwinds, tech stocks bleeding, and fears of a looming recession.
As per the Finance Bill, 2023, tabled in the Lok Sabha by the finance ministry, Section 56 of the IT Act pertaining to Angel Tax has been amended to include taxes on capital raised by unlisted companies from both resident and non-resident investors. Earlier, this was applicable to only resident investors.
“Angel tax is basically on the capital raised via the issue of shares by unlisted companies from an Indian investor if the share price of issued shares is seen in excess of the fair market value of the company. The excess realisation is considered as income and, therefore, taxed accordingly. This did not include foreign funds or investors earlier,” a Bengaluru-based veteran investor said.
However, the government earlier simplified the procedure for the startups to avail Angel Tax exemption by applying for the same before the Department of Promotion for Industry and Internal Trade (DPIIT), which would later be forwarded to the CBDT (Central Board of Direct Taxes) for the final approval.
Notably, the Angel Tax is being levied on startups at 30.9% on net investments in excess of the fair market value.
This, particularly, puts the startups that raise capital over and above their fair market value at disadvantage, as they will have to pay 30% tax on the excess amount they received from both domestic/non-domestic investors, according to the new provisions.
The global investment biggies like SoftBank, Tiger Global, which poured in a lot of capital in startups during the pandemic, shied away from large deals in 2022, according to the Inc42 analysis. It remains to be seen whether the fresh amendments under Angel Tax will further repel foreign funds, and investors from making fresh bets on Indian startups.
Did Startups Miss The Tax Sops Bus Again?
The push of the Modi government towards ease of doing business, removing compliance burdens for young companies and promoting investments into the ecosystem is well documented.
Finance Minister Nirmala Sitharaman, for instance, during her Budget speech on Wednesday, announced various provisions for startups, which include the extension of tax holidays for startups incorporated until April 2024 under Section 80-IAC of the Income Tax Act and allowing eligible startups to carry forward/set off their losses under Section 79 of the IT Act from current seven years to ten years.
Besides, the minister said that in order to push investments and promote ease of doing business (EODB), 39,000 compliances have been reduced and more that 3,400 legal proceedings have been decriminalised.
However, a long pending expectation of startups to avail the aforementioned tax benefits stands unaddressed yet again. As per Section 80-1AC of IT Act, only the startups with the Inter-Ministerial Board (IMB) certification will be eligible for tax SOPS.
As per government data, 89,812 startups have been recognised as startups by the DPIIT out of which 1,048 startups have tax exemptions.
Startups have been demanding an overhaul in the IMB certification process for a few years now, so that the tax sops can be extended to others too. But the Budget 2023 clearly fails to address this concern.
Despite the number of DPIIT registered startups growing to 89,812 so far from 30,000 in 2020, the number of startups receiving an IMB certification has increased marginally to 800 in 2022 from 485 in 2020.
High Surcharges For Unlisted LTCG Continue
While the Modi government’s move to cap Long Term Capital Gains Tax (LTCG) surcharges in the previous budget (2022-23) was appreciated, the reality is that the tax rate on LTCG for resident investors in unlisted companies continues to be 20%, compared to 10% for non-resident investors.
Startup founders have been demanding to reduce the surcharges to 10% for resident investors to boost investments. The finance ministry seems to have overlooked this demand too.
“The budget appears to be extremely well-balanced, as it focused on the 3 Cs – capex, consumption, and capital gains. Although the changes to the tax regime could dent the short-term revenue book, the higher tax base and strong GDP growth should lay down the long-term revolutionary path,” Sahen Karamchandani, founder, Wealthinindia.com said.
“Although the startup ecosystem will continue to sob with higher LTCG, moves like reduced compliance, extended time to carry forward the losses to 10 years, a boost to agri startup & MSMEs with support & credit, and the extension of tax holiday for startups would overall incubate a positive sentiment in the ecosystem, laying down a strong foundation for future entrepreneurs,” Karamchandani added.
The Burden Continues: ESOP Tax Deferment Missed Again
At a time when the startup ecosystem is going through a talent churn and layoffs, tax rebates on employee stock option plans (ESOPs) could have been a huge takeaway for the new-age companies.
After the Modi government announced the deferment of ESOP taxes for startup employees in 2020, the same was clubbed under Section 80 IAC of the IT Act. This naturally makes the majority of startup employees ineligible.
“The mid rung startup employees have to pay huge taxes without realising any profits before even the shares are vested. Barring the top executives, a majority of the startup employees have thus been wary of exercising these stock options,” a senior tax analyst said.
