‘Angel tax ends pref treatment of foreigners’
- ByStartupStory | February 3, 2023
According to a top government official, the return of the angel tax is nothing more than an attempt to level the playing field for domestic investors, which is currently skewed in favor of foreign entities.
The Union budget for 2023-24 proposes bringing foreign investors under the jurisdiction of the angel tax, which is levied on the premium to the fair market value of a company’s shares when it raises capital. Fears have been expressed in the investor and startup communities that the move will exacerbate the current funding crisis, especially given that foreign private equity and venture capital investments in Indian startups have fallen to $54 billion in 2022, down from $77 billion the previous year.
“There is no angel tax on startups. Let me be clear. (Section) 56.2 (VII B) used to have two provisions. One was the preferential treatment of foreign players. Preferential treatment has been done away with. But for startups, there is no change. A DPIIT-recognized startup will not attract angel tax if investment is made into that,” Anurag Jain, secretary, Department for Promotion of Industry and Internal Trade (DPIIT) said at a press conference.
Alternative investment funds (AIFs) registered with the Securities and Exchange Board of India (Sebi) will continue to be exempt from the tax, but domestic investors who are not registered with Sebi will have to pay it unless the startup they invest in qualifies for certain exemptions.
“It was a preferential treatment for foreigners compared to domestic (investors). Is that the right thing to do? You want to treat foreigners more preferentially compared to domestic players? Why should we not give a level playing field?,” Jain added.
Jain used the example of a Rs 100 cup as an example. “I give it (the cup) to you and you give me Rs 1,000. The underlying asset does not have the value of what you are giving. This can be used for doing hawala businesses,” he said, defending the premise of Section 56.2 (VII B).
According to Jain, there are enough safeguards in place to ensure that this is not aimed at startups. “We all understand that people invest in startups for their potential. Today, it may not be valued. But they know that it will be valued like this after a while; so, therefore they
invest. There is a proviso that this is not attracted for startups,” Jain added.
The industry, on the other hand, claims that the law, in practice, covers a huge number of startups and investors, a situation that is certain to worsen.
The DPIIT only registers 84,000 startups, leaving out a substantial portion of the ecosystem. There are strict requirements for those seeking angel tax exemptions: They will be barred from engaging in a variety of commercial activities for seven years after they cease to be startups. Such activities include the formation of subsidiaries, the advancement of loans, and stock M&A, which are commonplace for many businesses. Furthermore, those who have received an angel tax notice typically find it difficult to raise subsequent rounds of capital because new investors are concerned that the funds will be used to pay off tax demands.
According to Subramaniam Krishnan, an EY partner, the budget plan has far-reaching implications beyond the startup ecosystem.
“Sellers will price the fund-raise depending on the demand. If it is an attractive asset, which gets multiple investors, a valuation exercise is also an exercise in price discovery. There are multiple variables and future projections used while calculating valuation based on discounted cash flow models. On a practical level, we have noticed that tax officers tend to challenge the valuation provided by companies, issuing notices asking for justification,” he said.
Subramaniam went on to say that businesses would now have to strike a balance between the Foreign Exchange Management Act (FEMA) and Section 56.2. (VII B).
“The pricing guidelines under FEMA sets the floor price for the valuation, while Section 56.2 VII B sets the cap,” he said.
Follow Startup Story
Related Posts
