What is angel tax?
The ‘angel tax’ is a tax on the excess capital raised by an unlisted company through the issue of shares over and above the fair market value of those shares. This excess capital is treated as income and taxed accordingly. This tax most commonly affects start-ups and the angel investors who back them.
The tax, which was first introduced in 2012 to curb money-laundering through the sale of shares of private unlisted companies at bloated prices, has caused a lot of anguish among start-up investors in the country.
Why is angel tax required?
The IT department fears that start-ups may be used as convenient tools to launder illegally acquired money, so a tax on investments beyond a certain threshold is necessary to deter such shady operations.
What is the relevant issue?
According to a recent government notification in January 2019, start-ups whose aggregate amount of paid-up share capital and share premium after the proposed issue of share exceeds a certain threshold are to be taxed.
What problems start ups are facing?
Start-up owners have complained that income tax officials have asked many start-ups to cough up money when they try to attract capital into their entities by issuing new shares. The new rules could still result in an ‘inspector-raj’, where start-ups would have to apply to the DPIIT and the CBDT each time they find an investor.
Arbitrariness – While the intent of such an angel tax may be justifiable, the arbitrary nature of it means the cost of unintended consequences could be larger than the supposed benefits. In trying to curb money-laundering, Section 56(2)(viib) of the Indian Income Tax Act, 1961 gives income tax officials a free hand to harass even genuine start-ups looking to raise investments for their growth. Under the Act, the IT department is free to arbitrarily decide the fair value of a company’s share and tax start-ups if the price at which their new shares are sold to investors is higher than the fair value of these shares. The broad-brush tax on all investments means an unnecessary cost is imposed on the wider start-up community simply because of the lack of better means at the government’s disposal to tackle black money.
The real problem with the angel tax has to do with the unbridled power that it vests in the hands of the income tax authorities. Investors, foreign or domestic, may become wary of investing in new ideas when they are taxed while risking money on untested ventures.
The government should look to withdraw the angel tax and focus instead on building the capability to better identify and rein in illegal wealth. Otherwise it risks killing the nascent start-up ecosystem in the country.
Relief to start-ups
The Centre recently (in February 2019) notified new rules pertaining to angel tax which, will exempt registered start-ups of a specified size from the tax and any scrutiny to do with its applicability.
According to the new notification, investments of up to Rs. 25 crore (raised from earlier Rs. 10 crore) in an eligible company will be exempt from the angel tax. In addition, investments made by a listed company of a networth of at least Rs. 100 crore or a turnover of at least Rs. 250 crore would also be exempt. Investments made by non-residents will also be exempt.
The notification said that an eligible start-up would be one that is registered with the government, has been incorporated for less than 10 years, and has a turnover that has not exceeded Rs. 100 crore over that period.
Source: The Hindu