Presenting the Union Budget 2019 last week, Finance Minister Nirmala Sitharaman said that the startup ecosystem is key to India’s economy and its growth needs to be encouraged. “To resolve the so-called ‘angel tax’ issue, startups and their investors who file requisite declarations and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuations of share premiums,” the FM had said.
Naturally, this was something startups had been pining for and the government delivered on the expectations well. “The issue of establishing the identity of the investor and source of his funds will be resolved by putting in place a mechanism of e-verification. With this, funds raised by startups will not require any kind of scrutiny from the Income Tax Department,” Sitharaman added.
But that’s not all, as more measures could be put in place for startups and investors to enter into deals without too much friction. The government is likely to roll out new tax rules this September, to check the credibility and capacity of investors before a deal is finalised. “We would be modifying the return forms, which will allow the system to check if the investment made in the startup is genuinely made by someone capable of making that kind of investment,” a government official was quoted as saying by an ET report.
The idea is to remove any physical interaction between startups and their investors and the tax authorities by collecting data on the investors based on their tax returns to establish authenticity of the investment. This new returns form would supplement the everification process that was announced at the Union Budget 2019.
Acknowledging the current process for angel tax exemption, Sitharaman further said, “Special administrative arrangements shall be made by the Central Board of Direct Taxes (CBDT) for pending assessments of startups and redressal of their grievances. It will be ensured that no inquiry or verification in such cases can be carried out by the Assessing Officer without obtaining approval of his supervisory officer.”
Sitharaman also proposed to extend the Category I Alternative Investment Funds benefits to Category-II Alternative Investment Funds. And, therefore, the valuation of shares issued to these funds shall be beyond the scope of income tax scrutiny.
The Issue Of Angel Tax Exemption
Since the introduction of Section 56(2)(viib) of I-T Act — income from other sources — and the infamous angel tax os 2012 is applicable if the value of shares exceeds the fair market value, but for startups, angel investments became hard to come by as a result of the tax. According to Inc42’s The State Of Indian Ecosystem report, angel investments in 2018 were down by around 53% compared to the investments made in 2017.
Startups, since then, have fought a long battle pertaining to assessing fair market values. In the past, income tax assessing officers have repeatedly refused to accept the discounted cash flow (DCF method) of determination. Instead, they assessed the value based on NAV (Net Asset Value) method. This had resulted in startups getting tax notifications as part of Section 56(2)(viib).
Finally, in February this year, Suresh Prabhu, the then commerce minister after having a series of meetings with Indian startup ecosystem stakeholders as well as with the finance ministry officials announced the exemption of angel tax through a notification.