Only a start-up that is so classified by an inter-ministerial board (IMB) and incorporated on or after 1 April 2016 can apply to the government to avoid angel tax, the Department of Industrial Policy and Promotion (DIPP) said in a note sent to start-ups. Thanks to the new criterion, only a few dozen out of 7,200-odd start-ups have so far qualified for the exemption. Until now, entrepreneurs were under an impression that any start-up less than seven years old, merely registered with the government, and having revenue less than Rs25 crore could get the angel tax exemption.
The latest Union budget had spoken of facilitating the growth of start-ups, raising the hopes of angel investors who felt the government would soon fulfil their long-standing demand—an exemption from angel tax for all start-ups.
The controversial angel tax was introduced in 2012 and applies to capital raised by unlisted companies from any individual, including angel investors, against an issue of shares in excess of the fair market value. The capital is termed as ‘income from other sources’ and taxed at a rate of 30%.
The latest DIPP note circulated only a fortnight back said, “IMB validates the innovative nature of the business for granting tax-related benefits."
It also said profits of recognised start-ups with IMB certificates are exempted from income tax for a period of three years. The government recognizes a business as a start-up or as an early-stage business only if it is less than 7 years old. It is a prerequisite under commerce ministry to approach the government for any benefit as a start-up.
“This fiscal exemption is aimed at facilitating growth of business and meeting the working capital requirements during the initial years of operations," it said.
The note said only 86 startups have received tax benefits since 2012. It did not specify the nature of tax benefits. Mint has seen a copy of the note.
Nakul Saxena, fellow, iSPIRT Foundation, a software products think tank said, “Before the latest notification of DIPP, an IMB certification was not required.
IMB certification is a new requirement for getting angel tax exemption. Also, only post-2016 start-ups can apply." If the certification process is not made real-time and fast-paced, angel investors will face the crunch and the growth of start-ups will be affected, he added.
“We are working closely with DIPP and ministry of finance to ease rules for angel tax and bridge the gaps so that the start-up ecosystem does not get impacted," added Saxena.
The latest DIPP note says, “If a start-up, having certificate from IMB receives any consideration for issue of shares that exceeds the face value of such shares, then the aggregate consideration received for such shares as exceeds the fair market value of the shares is exempted from tax."
“Angel investment has anyway been declining due to the tax rules. The new rule is unfair because a start-up will not get angel investment despite being innovative if it does not have IMB certification," said the founder of a health food solutions firm.
“The government values start-ups at Rs0 because they are mostly loss-making. Now if an investor comes and puts in Rs1 crore for a 20% stake, the start-up’s notional value becomes Rs5 crore. The government imposes 30% tax on the start-up based on this notional value. Where will the money to pay tax come from? And if the tax is not paid, the income tax officials will seize the bank account, impose penalty, stop TDS refunds, file police complaint and interrogate harshly," this founder said on condition of anonymity.
A number of start-ups have been facing pressure from the Central Board of Direct Taxes (CBDT) for payment of angel tax. In the past, many start-up investors have openly criticized the tax department for this. In December, former Infosys Ltd board member T.V. Mohandas Pai had tweeted to finance minister Arun Jaitley that start-ups are being harassed by the income tax department for raising capital. “Very bad scene and very many are angry and upset, may shift overseas," said Pai, who has himself invested in several start-ups.
In February, CBDT issued a circular saying “no coercive measure" would be taken to recover the outstanding amount. It also directed its officers that in all such cases pending with the department where appeals have been made, “necessary administrative steps should be taken for expeditious disposal of appeals, preferably by 31 March 2018."
If there are changes in rules with regards to start-up investment attracting angel tax, they should apply only to start-ups applying for the rebate henceforth and not retrospectively, said Apoorv Ranjan Sharma, president and co-founder of Venture Catalysts, a network of over 4,000 angel investors.
“There is already a lot of confusion among angel investors and this would only add to the confusion," said Sharma. “Say if an investor puts in money assuming the start-up has already got an exemption from the tax, and later it goes to the (IMB) panel and learns that its certificate has been revoked, won’t the start-up as well as the investor feel cheated?" he said.