Angel Taxation

If you are an entrepreneur, you must be aware of the term “Angel Tax”. Under section 56(2)(viib) of the Income Tax Act, a startup in India is required to pay a definite sum in the form of tax. However, in the 2019 Union Budget, the government announced some relaxation. At the same time, to become eligible for angel tax exemption, it is necessary to meet certain conditions.

What is Angel Tax?

Angel Tax is a term used to refer to the income tax payable on the capital raised by unlisted companies via the issue of shares through off-market transactions. But then, what is the problem with that? Shouldn’t every company pay its due share of taxes? True, the catch is in the manner in which the angel tax is imposed and computed.

Angel tax is levied on the capital raised via the issue of shares by unlisted companies from an Indian investor if the share price of issued shares is seen as more than the fair market value of the company. The excess realization is considered as income and therefore, taxed accordingly.

Angel tax essentially derives its genesis from section 56(2)(viib) of the Income Tax Act, 1961. The Finance Act, 2012 introduced section 56(2)(viib) in the IT Act which taxes any investment, received by any unlisted Indian company, valued above the fair market value by treating it as income. The investment in excess of fair value is characterized as ‘Income from other sources’ and the tax imposed on it is known as Angel Tax since it largely affects angel investors investing in startups.

Drawbacks of Angel Tax

Take a look at some of the major drawbacks of angel tax:

  • Angel tax applies to startups that are funded by a resident Indian.
  • A startup earning an investment from venture capital and non-resident investors are not eligible for the deduction of angel tax.
  • Startups tend to lose a significant amount of money in the form of taxes as angel tax requires them to share a significant part of the investment.

Angel Tax Exemption

As discussed above, an angel tax causes a startup to lose a significant portion of its investment. The majority of startups cannot afford to lose this amount of money, especially in the initial

phase. The introduction of this tax in the amendment has received much criticism from investors, entrepreneurs, and industry analysts.

After startups made numerous pleas, the Indian Government implemented some relaxations in the 2019 Union budget. In this budget, the government stated that if the startup is registered under the DPIIT or Department for Promotion of Industry and Internal Trade, it would not be subject to such tax.

However, to be eligible for DPIIT, the startup needs to send an application along with the necessary documents to the Central Board of Direct Taxes or CBDT. After CBDT approval, they will be exempted from paying angel tax.

Apart from this, there are some other criteria that your startup needs to fulfill to file the required declaration and returns for angel tax exemption. Take a look below for a brief overview.

  • After issuing the shares, the startup’s maximum paid-up capital and share premium should not exceed Rs 25 crore.
  • As per Rule 11 UA (2)(b) of the Income Tax Act of 1961, it is imperative for the merchant banker to evaluate the fair market value of the startup.
  • The amount raised from venture capital firms, NRIs, and other specific companies is not included in the calculation. The startup’s yearly turnover should not be more than Rs 100 crore in any of the past fiscal years.
  • As per the income tax notification, angel investors are eligible for a 100% tax exemption on investing in startups with higher fair market value. However, to avail of this exemption, the average income of angel investors should not be more than Rs 25 lakh and should have a net worth of Rs 2 crore in the previous 3 fiscal years.
  • From the date of incorporation of a business, it can reap the benefit of a tax holiday for three consecutive years. During this period, the startup is exempt from paying taxes.

What are the Rates of Angel Tax in India?

The angel tax is levied at the rate of 30% in India, and an additional cess of 3% is also applicable to it as per section 56(2)(vii)(b) of the Income Tax Act, 1961. The effective rate of the angel tax is 30.9%.

What are the Changes in Angel Tax for Budget 2023?

Budget 2023 proposes that shares being issued to non-resident investors over and above FMV will be covered by the aforesaid provision of taxability. Moreover, the benefit of exemption from the ‘Angel Tax’ provided to domestic investors of eligible start-ups has not been extended to non-resident investors as yet.

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