This Is How Angel Tax Can Still Be A Problem For Startups

Last week, the finance minister has announced that startups registered under DPIIT will be given angel tax exemption. However, some startups have now reportedly expressed concerns saying that angel tax can still be applicable under certain cases. 

According to a media report, Siddharth Pai of 3one4 Capital said, “There are still things that startups do in their ordinary course of business that can deny them exemption from angel tax.” The report mentioned a February circular, issued by DPIIT, which says that to be eligible for this exemption, a startup should not give loans or make advance payments, invest in shares or securities or make capital contributions. 

“This means startups that have given salary advances or loans to employees, and those that have made advance payments for purchase of assets not eligible for the exemption from angel tax. It also closes the door on startups from engaging in M&A activity as such deals often include cash as well as stock options,” the report added citing experts.

The Ongoing Debate Around Angel Tax

Section 56 (2) (vii)(b) of the Income Tax Act (popularly known as Angel Tax) said that if a privately held company issues its shares at a price more than its fair market value, the amount received in excess of the fair market value will be taxed as income from other sources. 

Due to this provision, in November 2018, the Ministry of Consumer Affairs (MCA) issued notices to more than 2,000 startups that had raised money since 2013. The notices were mostly sent to the startups whose valuations had fallen after the first round of fundraising.

After much debate, the DPIIT and CBDT issued a notification on February 19, 2019 saying, “All the startups are allowed to receive angel tax exemption regardless of their share premium values given that the aggregate amount of paid-up share capital and share premium of the startup after issue or proposed issue of shares, if any, does not exceed, INR 25 Cr.”

At the time of notification, it was also widely discussed that a few pain points for startups remain the same: Section 68 and the certification process for the tax exemption under Section 80-IAC were yet to be addressed

The minister of commerce and industry Piyush Goyal earlier informed the parliament that the Central Board of Direct Taxes has exempted 702 startups under Section 56 (2) (vii) of the Income Tax Act, 1961 till June 21.

The government had also been trying to ensure that only genuine benefiting from the relaxation of angel tax rules, and if any startup fails in complying with the rules, it could be risking a severe angel tax penalty. The most recent addition to the rules includes a penalty of 200% on startups that don’t comply with angel tax requirements.

CBDT has issued a consolidated circular consisting of all the clarifications on the tax issues hurting the Indian startups, including the angel tax. These guidelines were issued to ensure that the startups recognised by the departments for the promotion of industry and internal trade (DPIIT) will not face any action.

The department has done so to simplify the assessment process for the startups. The present circular compiles all the announcements made in August 2019.