Angel tax: Investors from 21 nations exempted from angel tax

India exempted investments by non-resident entities such as sovereign wealth funds and pension funds from 21 countries from the so-called ‘angel tax‘, leaving out Mauritius, Singapore, and Luxembourg among others that account for significant equity inflow into the country.

Private equity and venture capital investment into closely held companies routed through jurisdictions not mentioned will have to undergo scrutiny under the angel tax provisions for valuation, as per a notification by the Central Board of Direct Taxes on Thursday.

Tax experts said this will restrict the benefit of the exemption to a select pool of investors as the country receives most of its foreign investment from jurisdictions left out of the list.

The Central Board of Direct Taxes (CBDT) issued the notification Thursday exempting foreign central banks, pension funds, sovereign wealth funds and endowment funds from 21 countries from the levy.

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The 21 countries are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US.

Mauritius has the highest share in cumulative foreign direct equity investment since April 2000 at 26%, followed by Singapore with 23%.

The share of the 21 approved jurisdictions is 29.1%, led by the US with 9.4%.

Investments by non-resident investors including multilateral entities, foreign banks and insurers, foreign portfolio investors and entities registered with the Securities and Exchange Board of India (Sebi) will not face the angel tax.

Broad-based pooled investment vehicles or funds where the number of investors is more than 50, barring hedge funds, have also been excluded from the tax purview, according to the notification.

The exemption will also be available to foreign investments in startups registered with the Department of Promotion of Industry and Internal Trade (DPIIT) but no changes have been made to the eligibility conditions to register.

Mixed Bag

Several FPIs are incorporated in excluded countries such as Mauritius, Luxembourg and Singapore.

“Such investors would still need to comply with the valuation guidelines provided under the Income Tax Act, 1961,” said Riaz Thingna, partner, Grant Thornton.

Tax experts say it would have been better if a “negative” list of countries had been notified, such as that of the Financial Action Task Force (FATF), given the legitimate concerns about entities registered there.

“Curiously, in this ‘positive’ list, even well-governed jurisdictions like Luxembourg and Singapore are excluded which means endowment and pension funds and all other pooled investment vehicles from these jurisdictions will not be afforded exemption form the valuation rules,” said Sudhir Kapadia, partner, tax and regulatory services, EY.

Fine print

In this year’s budget, the government amended the angel tax provision or Section 56(2) (viib) of the Income Tax Act, bringing foreign investment under its ambit. Before the amendment, the provision applied only to investments by Indian residents and funds not registered as alternative investment funds (AIFs).

Under Section 56(2)(vii)(b) of the Income Tax Act, if a closely held company issues shares at a price exceeding fair market value (FMV), computed in accordance with the prescribed methodology, the difference is to be taxed as income from other sources.

The tax impacts angel investment the most and therefore is popularly called the angel tax.

Investments by entities that have not been given a blanket exemption will have to provide valuation details to the tax authorities. The CBDT will soon issue the final notification on valuation.

Under the income tax law, FMV is decided using a discounted cash flow (DCF) method or net asset value (NAV) method. Since startups do not have much assets, they follow the DCF method that uses multiple assumptions, which usually leads to disputes.

The CBDT in the draft notification has proposed five methodologies for valuation and will accept valuation by a merchant banker.

Experts also said the move was in line with the government’s intent to prevent the circulation of unaccounted money.

“Therefore, exempting investments from regulated entities resident in countries with stringent and effective regulatory frameworks serves a logical purpose,” said Rakesh Nangia, chairman, Nangia Andersen India.