DIPP Raises Angel Tax Issues With Revenue Department

In less than 24 hours of minister of Commerce and Industry and Civil Aviation Suresh Prabhu’s response to the Twitter campaign against angel tax, the Department of Industrial Policy & Promotion (DIPP), in a press statement on Wednesday (December 19), stated that the DIPP has again taken this issue up with the Department of Revenue (DoR).

The DIPP asserted that the government is committed to protecting bonafide investments into startups and it has raised the issues with the DoR so that there is no harassment of angel investors or startups.

In April, this year,  DIPP in consultation with the DoR put in place a mechanism to grant exemption from the provisions of Section 56(2)(viib) of the Income Tax (I-T) Act to genuine investors in recognised startups. However, the arrangement has failed to address the issues of startups and investors at large.

Speaking to Inc42, Siddarth Pai, founding partner of 3one4 Capital, said: “The IMB (Inter-Ministerial Board) process for getting an exemption from this angel tax only applies to those companies incorporated after April 1, 2016, and those who receive the IMB certification. But the startups receiving the notices now were incorporated prior to that. Furthermore, as of January 2018, only 74 out of 6000 odd startups have received this IMB certification”

Further, the IMB qualifying and approval criteria are not only inefficient but also irrelevant as it also involve whether a startup is innovative enough or not (at the time of filing the application). 

Sharad Sharma, cofounder of iSpirt Foundation told Inc42, “The government should not play any role to determine if the startup is innovative or if it will succeed or not. Also, an ecommerce startup may be able to raise money even today but cannot be considered Innovative in 2019 but was innovative in 2013 or earlier. As long as the funds have come into the firm via the banking channel for a purpose and the funds utilised have happened towards the said purpose only. This should suffice.”

99% of the companies incorporated after April 1, 2016 are susceptible to get the I-T notice in the future. Pai added, “The solution needs to encompass any startup who meets the DIPP definition since it doesn’t have an artificial time restraint for incorporation. Why should those who started their entrepreneurial journey a little earlier be exposed to such draconian measures?”

LocalCircles Files A Formal Submission To DIPP

Meanwhile, the community-based social media platform, LocalCircles, which also has a startup and SME community with over 30K members, met the commerce minister and DIPP joint secretary Anil Agrawal, and filed a formal submission asking for immediate relief measures as well as more permanent reforms for the startup ecosystem.

Sachin Taparia, founder and MD of LocalCircles told Inc42, “I met minister Suresh Prabhu yesterday to discuss the angel tax matter. The minister too was of the opinion to completely erase the angel tax issue.”

LocalCircles has asked the DIPP to quash the I-T notices as CBDT (Central Board of Direct Taxes) did earlier in February, this year.

Angel Tax: What Startups Demand

Recently, a number of startups have complained that the assessing officers (AO) have refused to accept the Discounted Cash Flow (DCF) method used by the startups for its valuation despite being approved by chartered accountants and merchant bankers.

Instead, AOs mostly go for the Net Asset Value method (NAV) and reject the valuations given by startups. This creates big issues for startups whose revenue can be small or none.

Pai said that it’s not AO’s prerogative to choose the valuation method but to follow due process. Section 56(2)(viib) leaves the choice of the valuation method up to the assessee company, not the assessing officer.

Instead, “the AOs are putting themselves in the shoes of the investor and determining the valuation of the company. The CBDT needs to issue a clear circular that the AO cannot contest the valuation methodology so chosen or compare the valuation report with the actual performance of the company. There are even case law and ITAT rulings bolstering this” Pai said.

LocalCircles in their submission addressed to the joint secretary, DIPP, has demanded that the DCF method should be accepted by AOs in case of all recognised startups.

Taparia said, “We have also demanded that in cases of orders issued by CBDT under Section 56 (2) (viib) of the Income Tax Act, must be disposed and the notification must be issued latest by December 24, so that the startups could take the same to their AOs, and avail relief in time.”

It is worth noting that some startups who earlier received I-T notices and failed to justify their investments have now been issued orders asking to make the entire payment in the next 30 days or 20% of the payment immediately and file the appeal.

Sharma said: “In the short-term, the government needs to go easy on the startups until a long-term measure is put in place. Secondly, all startups that have done the first level of registration should be exempted from paying the 20% deposit if they are appealing the order. Also, all startup cases of appeal should be expedited by 31st March 2019”

Pai too averred that the I-T department should declare that any such startup aggrieved by this should not be liable to pay the 20% deposit to appeal the process. All the pending cases should be allowed time till March 31st, 2019 to submit the PAN of their investors and the PAS 3 (Return of allotment) forms filed with the RBI & RoC (Registrar of Companies, Ministry of Corporate Affairs) to prove that the funds have come through normal banking channels and that the investors have been identified.

“Creditworthiness can be divined from their Income Tax Filings since anyone earning more than 50L in salary, all businesses & professionals need to file their financials with their income tax returns,” Pai added.

Angel Tax Exemption: The Long-Term Cure Might Take Longer

Pai pointed out, “The tax department should respect capital receipts as capital receipts and not tax them as revenue – this goes against the principle of income taxation.”

While the final solution lies in Section 56 (viib) amendment through the Finance Bill with making an exemption for startups, the ongoing winter session of the parliament is the last full-fledged session for the current Modi regime.

It is unlikely that any special bill will be introduced in this session.

Sachin said that DIPP and I-T department should link their systems via an API which would help I-T department to identify a DIPP-recognised startup and generate a special flag and even if the CBDT systems auto-generate a notice under the Section 56 (2) (viib), it could get auto-nullified.

All eyes are now on the Department of Revenue and the Ministry of Finance. Will Arun Jaitley be able to address the issue in time?

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