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Understanding Angel Tax
What is Angel Tax?
Angel Tax refers to the tax levied on startups when they receive investment exceeding their Fair Market Value (FMV) from angel investors. This tax is specified under Section 56(2)(viib) of the Income Tax Act, 1961, and was introduced to prevent money laundering. If a startup receives funding that surpasses its FMV, the excess amount is taxed as “income from other sources” at a rate of 30.9%.
Budget 2024 Update
In a significant move to bolster the startup ecosystem, the Indian government has abolished the Angel Tax for all investor classes starting from FY 2024-25.
Reason for abolishing
- To Reduce Compliance Burden for Startups.
- Methodology: The assessing officer used the discounted cash flow (DCF) method to determine fair market value, which is considered an unfavorable practice for startups.
- DCF evaluates investment by discounting the estimated future cash flows.
- It reduces FDI (foreign direct investment) into India.
Abolishing the Angel Tax is also in line with the government & Startup India initiative.
Example of Angel Tax
Consider a scenario where a startup receives Rs 15 crore from an angel investor. If the FMV of the shares issued is Rs 10 crore, the excess Rs 5 crore is subject to a 30.9% tax, resulting in a tax liability of Rs 1.545 crore.
Drawbacks of Angel Tax
- Applicability to Resident Indian Investors: Angel tax is only applied to investments from resident Indian investors, not from venture capital or non-resident investors.
- Financial Burden on Startups: Startups lose a substantial portion of their investment to taxes, which can hinder their growth and development.
Angel Tax Exemption
To address concerns from the startup community, the 2019 Union Budget introduced exemptions for startups registered under the Department for Promotion of Industry and Internal Trade (DPIIT).
Conditions for Exemption:
- DPIIT Registration: The startup must be registered under DPIIT.
- Capital and Premium Limits: The total paid-up capital and share premium post-issuance should not exceed Rs 25 crore.
- Fair Market Value Assessment: A merchant banker must evaluate the startup’s FMV.
- Exclusion of Specific Funds: Investments from venture capital firms, NRIs, and certain companies are excluded from the calculation.
- Turnover Cap: The startup’s annual turnover must not exceed Rs 100 crore in any past fiscal year.
- Investor Criteria: Angel investors must have an average income of less than Rs 25 lakh and a net worth of Rs 2 crore in the previous three fiscal years.
- Tax Holiday: Eligible startups can enjoy a tax holiday for three consecutive years from the date of incorporation.
Angel Tax Rate
Angel tax is levied at a rate of 30.9% on investments exceeding the startup’s FMV.
Example
Suppose a startup receives Rs 50 crore by issuing 1 lakh shares at Rs 5000 each, with an FMV of Rs 2000 per share. The FMV of the shares is Rs 20 crore, leaving Rs 30 crore as excess. The angel tax on this excess would be Rs 9.27 crore (30.9% of Rs 30 crore).
Despite exemptions, the concept of Angel Tax has faced significant criticism for hampering startup growth. The abolition of Angel Tax from FY 2024-25 aims to foster innovation and entrepreneurship in India’s startup ecosystem.
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