Draft rules to fix angel tax issues in a week

Startups, grappling with a funding squeeze amid tightening interest rates globally, feared that planned changes to the angel tax would drive away foreign investments.

“We have had extensive consultation with all the associations and we have submitted their suggestions to the ministry of finance. [The proposed solution] will be in the form of a draft consultation and it would address the issue of differences in terms of valuation technique used under the income tax act and the FEMA act, " a government official stated.

“The dichotomy [between the two] will most likely be done away with. Draft rules will be issued in a week or ten days," the official added.

The startup ecosystem, which relies heavily on foreign capital and typically issues shares at a premium to the fair market value (FMV) on the promise of future growth, was particularly concerned that an amendment in Section 56.2.Vii b could be applied for foreign investments.

Mint had earlier reported that the government is contemplating exempting foreign funds from angel tax compliance, and rules on angel tax are expected to be issued this month, outlining exemptions for select foreign entities that are bona fide investors.

Foreign PE/VC funds announced investments worth $77 billion in 2021, which dropped slightly in 2022 to around $54 billion, according to EY.

The first set of foreign funds likely to be exempt includes sovereign wealth funds such as Abu Dhabi Investment Authority, GIC, and Qatar Investment Authority. This is due to concerns that the potential impact of Section 56.2 Vii B tax could negatively affect foreign investments, which may undermine the government’s infrastructure investment push.

The government had previously argued that the angel tax, or Section 56(2) VII B, targets ‘hawala’ transactions rather than startups and that ending ‘preferential treatment’ for foreign investors would level the playing field since Indian residents are already subject to this tax.