Start-ups to be taxed on funds from angel investors

Start-ups to be taxed on funds from angel investors
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First Published: Sun, Mar 18 2012. 02 19 PM IST

Updated: Mon, Mar 19 2012. 11 37 PM IST
Mumbai: Start-ups raising money from angel investors will have to pay income tax from April on the funds they receive after the national budget on Friday proposed to treat the capital received as income from other sources, if the consideration received for issue of shares exceeds the face value of such shares.
For instance, consider an angel investor who plans to invest Rs 10 lakh in a start-up that has Rs 100,000 as paid-up capital, or 10,000 shares at a face value of Rs 10. To give the investor a 20% stake, the start-up will have to issue 2,000 shares. However, since the investor plans to infuse Rs 10 lakh, he acquires the shares at Rs 500 apiece, much more than the face value.
In India, experts estimate that nearly 90% of start-ups fold up in the first two years of their inception for lack of funding support.
Angel investors include corporate chiefs, businessmen and wealthy individuals who invest their own capital—mostly between Rs 20 lakh and Rs 1 crore—in firms that are often nothing more than business ideas. In India, such investments are tiny—estimated at less than $300 million in three years—but still represent an important source of capital for start-ups. Angel investors typically invest in companies that deal with sectors that personally interest them, and are often the first investors in a company.
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Mint’s Deepti Chaudhary says startups raising money from angle investors will have to pay income tax, starting April under a new provision enumerated in the budget.
“This clause will completely kill all angel investment in the country and with that, spell the death knell of first-generation entrepreneurship that had begun to mushroom over the last few years,” said Indian Angel Network Services Pvt. Ltd co-founder Saurabh Srivastava, adding that various measures enunciated for small and medium-size enterprises (SMEs) will come to naught because of this one clause because angel investment precedes venture capital investment.
“Rather than giving the angel investor a tax break for making such risky investments for the common good (creation of wealth and employment), as is done by most countries in the world, we are in effect taxing them and, therefore, encouraging them to put their money in unproductive assets like farm houses and real estate,” said Srivastava.
Start-ups are important for the growth of any economy not only for the growth of businesses but for job creation. According to a Kauffman Foundation Study in 2010, job growth in the US was driven entirely by start-ups. New firms added an average of 3 million jobs in their first year, while older companies lose 1 million jobs a year, it said.
“Instead of going forward what we have are regressive proposals,” said Sasha Mirchandani, co-founder at Mumbai Angels and managing partner at Kae Capital. “It only shows that the government does not understand the value of start-ups.”
In countries such as Singapore, the government helps start-ups through measures such as tax benefits and subsidized office space, Mirchandani said. “Here we are going backwards. This will impact new people getting into angel funding,” he said. “It will make angel funding unattractive for start-ups.”
The tax provision, however, will not apply when the consideration for issue of shares is received from a venture capital fund. Venture capital (VC) funds have larger deal sizes (typically above $2 million) and the companies have a proof of concept and some revenue traction.
Angel networks have the option of registering themselves as VC funds, but it is not something they are keen to do. “As angels, we have the freedom of choice of investing in business models that we like and understand. If we become a VC fund, that freedom gets lost,” said Anil Joshi, vice-president at Mumbai Angels, which has a portfolio of over 40 companies.
Promoters have begun accelerating their fund-raising process from angels to escape the tax clause. Bangalore-based, which tracks start-ups in the country, is now looking at closing fund raising before 31 March. “If I need to give 30% to the government, what is left for me?” asked its head Ashish Sinha.
Sinha said such clauses will encourage infusion of black money into start-ups or investors will increasingly look at convertible debentures, where the start-up takes on the investment as debt and with time it gets converted into equity.
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First Published: Sun, Mar 18 2012. 02 19 PM IST