Angel Tax is a term basically 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 in that? Shouldn’t every company pay its due share of taxes? True,
Angel tax essentially derives its root 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
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.
Which Investments are part of Angel Tax?
Angel tax is imposed only on investments made by a resident investor.
It is not applicable in case the investments are made by any venture capital funds or non-residents.
Angel Tax Exemption
However, in order to qualify for angel tax exemption, the startup should meet certain criteria which are as follows:
- It has been recognized by DPIIT
- Aggregate amount of paid up share capital and share premium of the startup after issue or proposed issue of share, if any, does not exceed, 25 crore rupees:
The aggregate amount of Rs 25 Crore paid up share capital does not include:
Shares Issued to a non-resident or
a venture capital company or a venture capital fund
Restrictions On Usage of the Funds
It has not invested in any of the following assets,
(a) building or land appurtenant thereto, being a residential house, other than that used by the Startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
(b) land or building, or both, not being a residential house, other than that occupied by the Startup for its business or used by it for purposes of renting or held by it as stock-in trade, in the ordinary course of business;
(c) loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is substantial part of its business;
(d) capital contribution made to any other entity;
(e) shares and securities;
(f) a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
(g) jewelry other than that held by the Startup as stock-in-trade in the ordinary course of business;
(h) any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-clauses (iv) to (ix) of clause (d) of Explanation to clause (vii) of sub-section (2) of section 56 of the Act.
In order to simplify the compliance procedure, the government in a recent notification has done away with the requirements fair market value certificate issued by a merchant banker and approval from an inter-ministerial board via New Notification.
The eligible startup can simply request exemption from the Department of Industrial Policy & Promotion (DIPP) with applicable supporting documents.
The application of DIPP-recognised startups will be forwarded to CBDT (Central Board of Direct Taxes) along with a documents.
CBDT has been mandated to accept or decline such an application within 45 days from the day of receipt.
FORM 2 is required to File claim Exemption From Angel Tax on Startup India Website
Rate of Tax
Angel Tax is levied at a hefty rate of 30.9% on net investments in excess of the fair market value.
So for example, if a startup receives 50 crore of investment by issuing 1 lakh shares at Rs.5000 each to an Indian investor and the fair market value is Rs.2000 per share i.e Rs.20 crore only,
then the startup will have to pay tax on the amount in excess of the fair market value i.e Rs. 30 crore.
Therefore Tax payable in this transaction will be Rs. 9.27 crore (30.9% on Rs.30 crore).
Why the startup community against it ?
In Angel Tax imposition issue is on the fair market valuation of the company and this has been a bone of contention between startups and the department.
The tax department goes by the rule book and calculates market value based on the net assets of the company. However, estimated growth prospects of the startup and future projections based on these growth prospects are major factors in determining the fair market valuation of the startup.
The methodology difference in calculation of the market value of the startup makes it pay a hefty price in terms of tax at a whopping 30%. Angel tax in a way wipes away a major part of the investible surplus of the startup hurting its growth prospects and hitting hard on the viability of the business.
However, after facing a sustained backlash from the startup ecosystem against the imposition of ax, the government has finally assured the startups that no coercive action will be taken to collect tax and also appointed a committee to look into this issue
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