Venture Capital: VC funds plan to approach IT dept on angel tax exemption list

The exclusion of investor-friendly jurisdictions such as Mauritius, Singapore, the Cayman Islands and the Netherlands from the list of countries not attracting angel tax provisions has irked venture capital firms, which plan to approach the income tax department seeking protective measures against the tax.

According to a notification by the Central Board of Direct Taxes (CBDT), sovereign wealth funds, pension funds and Sebi-registered portfolio investors from 21 jurisdictions will be exempted from the provisions of angel tax. These countries include Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US.

Overseas investors use complex corporate structures with offshore entities based in jurisdictions like Singapore, Mauritius, etc to avoid attracting tax on their investments in India.

“Countries like Mauritius and Singapore have established themselves as preferred jurisdictions for investments into India and their exclusion from the list is very surprising to the industry. Before the establishment of GIFT City, investors flocked to Singapore, Mauritius and Cayman structures for investments into India,” said Siddarth Pai, founding partner at VC firm 3one4 Capital, and co-chair, regulatory affairs council, at the Indian Venture and Alternate Capital Association said.

The angel tax is applied on the basis of Section 56 (2) (viib) of the Income Tax Act. According to this provision, any difference between the fair market value and the face value of shares issued by a company is taxed.

“Investors in the exempted jurisdictions like the US, Austria, Belgium, etc also choose to invest in India through Mauritius, Singapore, etc as part of their Asia strategy. They normally have offices and teams based in those locations. So, the exclusion of Mauritius and Singapore is a particular note to the industry because a number of VCs (venture capitalists) have active funds in these jurisdictions,” he added.

Mauritius, Singapore, the Netherlands and the Cayman Islands are among the top 10 jurisdictions that bring in foreign direct investment (FDI) in India. According to data sourced from the Department for Promotion and Industry and Internal Trade, FDI inflow from Singapore stood at $13.08 billion during April-December 2022, while Mauritius was $4.73 billion. The FDI inflow also includes the amount invested in securities that do not attract the angel tax.

“The industry will now attempt to reach out to the Central Board of Direct Taxes and the government to understand if there are additional protective measures that we can put in place to allow investments from Mauritius and Singapore to come into India without being taxed under 56(2)(viib),” he added.

Global funds in a flux

Several investors that ET reached out to said that they are still reviewing the notification and are expected to meet with the larger industry to seek a cohesive understanding from the government on the matter.

“A large chunk of capital infused in Indian startups is foreign capital (from vehicles based in Singapore and Mauritius) and has over the years led to the (startup) ecosystem’s growth and taken the count to over 100 unicorns. Now, for a startup founder wanting large cheques the solution remains to move out of India,” said an investor who spoke to ET on condition of anonymity and was reviewing the new rules issued by the government.

Investors are worried that the current move by the government will hurt inflow of capital into the country, encourage flipping of companies outside India and add an irrational compliance burden on startups.

This comes at a time when several Indian companies like PhonePe have already changed their domicile in the country and several such as Razorpay are looking to shift headquarters back into the country. PhonePe parent Walmart and its investors had to pay a hefty Rs 8,000 crore in taxes for the fintech’s flip, ET reported earlier.

“It is going to be clear that limited partners (LPs) at these global funds will ask managing partners to shift allocation away from India and focus on other emerging markets, and it is the worst thing that can happen to the Indian startup ecosystem. Especially at a time, when India has been coming out as a bright spot for investing in the global race and has shown resilience to global recession,” said a second person at a venture capital firm, who didn’t want to be named.

However, the move on angel has got the industry thinking whether the government wants these global funds to set up shop at the much-promoted GIFT city.