A CBDT circular has notified that the provisions of Section 56(2)(viib) of the Act will not be applicable to startups that are recognised by the DPIIT and meet specific conditions
A startup can qualify for an angel tax exemption if it has received recognition from DPIIT and the combined value of paid-up share capital and share premium of the startup after issuing or proposing to issue shares, if any, does not exceed INR 25 Cr
Experts believe that while INR 25 Cr limit is considered inadequate for startups, G.S.R. 127(E) circular that delves into the angel tax exemption makes ordinary business operations almost impossible for any startup to follow
Amid the ongoing controversy surrounding startups receiving notices under Section 56(2)(viib), aka angel tax, and being asked to furnish income tax returns (ITRs) of their stakeholders for the past three consecutive years, the Central Board of Direct Taxes (CBDT) has issued a circular to its senior field officers.
The circular states that the provisions of Section 56(2)(viib) of the Act will not be applicable to startup companies that are recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) and meet the conditions outlined in paragraph 4(i) and 4(ii) of Notification No. G.S.R. 127(E).
According to paragraphs 4(i) and 4(ii) of Notification G.S.R. 127(E) issued on February 19, 2019, a startup can qualify for an angel tax exemption if – 4(i): It has received recognition from DPIIT under paragraph 2(iii)(a) or as per any prior notifications on the subject. And 4(ii): The combined value of paid-up share capital and share premium of the startup after issuing or proposing to issue shares, if any, should not exceed INR 25 Cr.
It’s important to note that the calculation of this value excludes the shares issued to VCs.
In this context, it’s essential to highlight that the Finance Act of 2023 has modified clause (viib) of sub-section (2) of Section 56 of the Act by removing the phrase ‘being a resident’, effective from April 1, 2024.
There have been instances of startups being subjected to scrutiny under the Computer-Assisted Scrutiny Selection (CASS) process. Given the circumstances, the procedure for assessing recognised startups that meet the DPIIT’s criteria as outlined in paragraphs 4(i) and 4(ii) of the DPIIT notification is clarified.
According to the notification, if a startup is selected for scrutiny solely based on the applicability of Section 56(2)(viib) of the Act, assessing officers will not conduct verifications on this issue during the proceedings under sections 147/143(2) of the Act, and the contention of recognised startups regarding this issue will be summarily accepted.
If a startup is chosen for scrutiny with multiple issues, including Section 56(2)(viib) of the Act, the angel tax issues will not be pursued.
According to Dr Somdutta Singh, the founder and CEO of Assiduus Global Inc., an angel investor, the directive from the CBDT is a positive step towards addressing the angel tax issue for startups.
“It provides relief to startups recognised by the DPIIT from unnecessary scrutiny under Section 56(2)(viib) of the Income-tax Act. Startups meeting the DPIIT’s criteria will not be required to file Form 2,” Singh said.
However, it’s crucial to acknowledge that angel tax-related challenges may still exist for startups that don’t meet the DPIIT’s criteria.
The Ongoing Challenges With Angel Tax
Meanwhile, highlighting several key issues with the circular G.S.R 127(E) dated February 19, 2019, Siddarth Pai, the founding partner of 3One4 Capital stressed that the circular’s main issues on ordinary business operations are impossible for any startup to follow.
For a period of seven years from the last time they issued shares at a premium, startups cannot:
- Give any loans & advances (except for pending companies)
- Invest in shares & securities
- Make capital contributions
This limitation creates challenges for activities such as salary advances, creating an Employee Stock Ownership Plan (ESOP) pool, establishing subsidiaries, forming joint ventures, and acquiring companies using stock. Moreover, the circular’s INR 25 crore limit is considered inadequate for many startups, particularly those seeking substantial funding. As a result, this circular fails to address these pressing concerns.
Additionally, there are significant penalties associated with violations of these conditions. Companies may face penalties amounting to twice the tax amount due, which is already set at 25%. Taking interest, etc into account, this results in a high effective cumulative rate up to 90%. Therefore, the existing circulars do not effectively address these critical issues, leaving many unanswered questions and concerns within the startup community.
Pai further pointed out that the practice of comparing a company’s actual performance to projections remains unresolved. Despite changes in regulations, the startup ecosystem still lacks clear and concrete solutions.
To address the traceability issue, he proposed that companies issuing shares at a premium should dematerialize securities, making it easier to trace details. He also highlighted that investors are now mandated to report unlisted investments to the tax department, facilitating transparency.
Startups too must report any security issuances above INR 10 Lakhs. Along with dematerialisation, this will create a chain of traceability for the tax department to allow them to pursue those who use investments at a premium to circulate unaccounted funds. Nevertheless, the startup industry continues to seek more definitive and practical solutions to these challenges.
In conclusion, while some steps have been taken to alleviate the angel tax issue for recognised startups, there remain significant concerns and uncertainties within the startup ecosystem. The industry and regulatory authorities must continue to work together to develop effective solutions that address the evolving needs of startups in India.
Earlier, in response to an RTI filed by Inc42, the DPIIT revealed that between April 1, 2019, and September 26, 2023, 10,809 DPIIT-recognised startups applied for the exemption, yet only 8,066 have been green granted exemption.
