This means privately held companies such as startups that issue shares to foreign investors at a premium may be subjected to additional taxation requirements.
What has the Budget proposed?
According to the proposal, the excess premium received on the sale of shares by an Indian unlisted company to a foreign investor will be construed as “income from other sources” and subject to tax.
The provisions will apply to all individual foreign investors, market experts told ET, adding that there is a need for further clarity on whether it will also apply to foreign investors structured as funds and institutional investors.
The changes to the provisions under which angel tax is levied will become effective from April 1, 2024 and will be applicable from assessment year 2024-25 onwards.
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What is angel tax and why is it levied?Angel tax is a term used to refer to the income tax payable on capital raised by unlisted companies via the issue of shares where the share price is seen in excess of the fair market value of the shares sold. The excess realisation is treated as income and taxed accordingly.
It has come to be called angel tax since it largely impacted angel investments in startups.
When was it first introduced and its context?
The tax was first introduced in the 2012 Union Budget by then finance minister Pranab Mukherjee under the UPA-II regime to arrest the laundering of funds.
The government issued a notification in April 2018 to give exemption to startups under Section 56 of the Income Tax Act in cases where the total investment including funding from angel investors did not exceed Rs 10 crore.
For the exemption, startups were also required to get approval from an inter-ministerial board and a certificate of valuation from a merchant banker.
How does it impact startups?
According to the rule, any premium paid by an investor in excess of the fair market value (FMV) of an unlisted company is subject to a 20% tax. Market participants say to avoid this tax, startups will now be forced to maintain a more linear valuation path and ensure there are no large swings in valuations between different rounds of funding.
In cases where there are such swings, the tax department may question the FMV calculation of the share sale that happened at a lower price. The issue assumes significance as the bulk of the Indian startup capital comes from foreign funds. Until now, the FMV restriction didn’t apply to shares sold to foreign investors.
In 2018, the industry demanded that the discounted cash flow (DCF) method of valuation be used to calculate angel tax instead of the NAV method, though even that may not capture the true value of a startup.
What is the industry’s view on this?
Industry players and experts are of the view that the inclusion of offshore VC funds as non-residents for angel tax can create a sense of uncertainty and fear in the minds of Indian entrepreneurs.
“This will also create issues with multiple valuation methods for FEMA (Foreign Exchange Management Act) and tax purposes … government needs to clarify this quickly,” said Anand Lunia, founding partner at India Quotient, an early-stage fund.
“This will create a tax liability for Indian companies and the revenue authorities may also try to question the valuation reports more often,” said Amit Singhania, partner, Shardul Amarchand Mangaldas.
(Illustration by Rahul Awasthi)