Govt Eases Angel Tax Exemption, Expands Definition of ‘Start-Ups’

Start-ups will be able to avail for exemption upon a one-time submission of documents to DPIIT.

Following a series of appeals by aggrieved start-ups and investors, Suresh Prabhu, minister for Commerce & Industry, has cleared proposals for easing the requirements for ‘angel tax’ exemption.

Among the major changes announced in the gazette notification is a new expanded definition of start-ups, easing rules for investors and a one-time submission of documents by start-ups in order to avail of exemption from ‘angel tax’.

The move comes after hundreds of start-ups, hounded by ‘angel tax’ orders, had appealed to Prime Minister Narendra Modi on 16 January to scrap the tax, stating that the distress in the ecosystem caused by the levy could “derail the entire Start-up India movement”. 

However, the demand from the start-up community to do away with the tax altogether had been declined by ministry officials. The reason cited was shell companies using start-ups to park black money. All start-ups registered and recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) will be eligible for this exemption.

‘Angel Tax’, at the heart of the discontent and distress among start-ups, under Section 56(2) (vii)(b) of the Income Tax (I-T) Act, taxes as income any investments made by an Indian entity in an unlisted Indian company above fair market value.

Entrepreneurs and investors consider ‘angel tax’ an outrageous levy which places the power to ‘value’ start-ups in the hands of inspectors whose evaluation methods are at odds with the start-up ecosystem.

‘Start-Up’ Gets a New Definition

The gazette notification, which comes into effect from Tuesday, supersedes the one issued on 11 April 2018.

An entity shall now be considered a start-up if:

1. Upto a period of ten years from the date of incorporation/registration, it is incorporated as a private limited company or a limited liability partnership in India.
2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees.
3. Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

According to the notification, to be eligible for exemption, a start-up must satisfy the following conditions:

1. It has been recognised by DPIIT
2. Aggregate amount of paid up share capital and share premium of the start-up after issue of share does not exceed twenty five crore rupees:
3. The start-up shall file a signed declaration to DIPP that it fulfills the above conditions. The DPIIT will forward the same to the CBDT.

The exemption, however, relates only to section 56 of the Income tax Act. Start-ups had also requested for easing of provisions under section 68 which deals with cash credits which had not been granted. A recent case of start-up Travelkhana’s bank accounts being frozen and its balance of Rs 34 lakh taken out by income tax officials falls under section 68 of the IT Act.

What Led to The Easing of ‘Angel Tax’ Exemptions ?

On 4 February, about 40 start-up founders and investors had met officials from the DPIIT and the Central Board of Direct Taxes to voice their grievances.

On the same day, a survey published by Indian Venture Capital Association and LocalCircles revealed that among 2,500 start-ups that responded, 73 percent admitted to having received at least one angel tax order after raising an angel investment.

After the meeting on 4 February, a core-group of start-up representatives had met with DPIIT and CBDT officials and submitted a list of recommendations on behalf of the start-up sector.

“CBDT and DIPP have accepted our recommendations as is for resolving Section 56(2)viib which is very heartening to see,” said Sachin Taparia, Founder of LocalCircles, who was a part of the core team that had submitted the recommendations.

“This eliminates a major obstacle for Indian start-ups and if implemented right, could give a significant boost to the Indian start-up ecosystem as individuals with tax paid income as well as corporates will be able to easily participate in start-up investments.”

Sachin Taparia, Founder of LocalCircles

Why Were Start-Ups Angry ?

A desperate plea by 68 startups in a letter to Prime Minister Narendra Modi on 16 January not only illustrated the distress caused by ‘angel tax’, but also served as an indictment of the government’s various start-up initiatives.

“Start-ups are in distress and many feel victimised mainly due to the subjectivity, cost and arbitrariness involved in the implementation of this anti-evasionary measure which treats every assessee as guilty until proven innocent.”

Excerpt from the letter to PMO signed by 68 start-ups

Hundreds of start-ups that raised angel funding in AY2015-16 and 2016-17 have received notices from the Income Tax department. The notices question the high share premium at which the shares have been allocated during the funding.

The mismatch between how investors evaluate a start-up and how the Assessing Officer (AO) does so lies at the heart of the unrest and distress within the community.

“The tax inspectors only understand the asset-based evaluation of companies, whereas what should be followed is the Discounted Cash Flow (DCF) method, which takes into account future growth prospects. This is much more accurate for asset-light technology start-ups.” Sreejith Moolayil, founder of health snack start-up, TrueElements had told The Quint.