Why in news? –  Finance Minister proposed to abolish the angel tax for all investor classes while presenting the Union Budget 2024-25.

The Origin of Angel Tax: – The idea of angel tax was first introduced in the 2012, Union Budget by then Finance Minister Pranab Mukherjee.

What is Angel Tax? – Initially every new stablished company needs funds to perform its activity and seeks investment but having no tangible asset as collateral but equity, at this phase an angel investor can invest money in it. Investment greater than FMV (Fair Market Value) is categorised as “income from other sources”, and the tax imposed on it is called angel tax.

Angel tax, formally as section 56(2) (vii b) of the income tax Act, is the tax imposed on funds raised by start-ups from angel investors. However, this implies only to fund that exceed the fair market value of the company.

The Fair Market Value of a private company’s stock is the predicted value of one share of your company if your stock was available on the open market

Why was angel tax introduced? –

• Considering this view that most new businesses don’t keep up with the appropriate account books or show their assets correctly, leading to the creation of black money in India. Due to this flaw, Govt. decided to tax the private companies on excessive share premiums received above the FMV.
• The complicated nature of Venture Capital fundraising with offshore entities, multiple limited partners and blind pools is contentious. The Primary Objective was to check money laundering practices through investments in start-up and catch bogus firms after advent of such cases.

Angel Tax Exemption

Startups made numerous pleas for this tax exemption, Government provide some relaxations in the 2019 Union budget, and stated that if the startup is registered under the DPIIT or Department for Promotion of Industry and Internal Trade, it would not be subject to such tax.

There are some other criteria that your startup needs to fulfil to file angel tax exemption.

• After issuing the shares, the startup’s maximum paid-up capital and share premium should not exceed Rs 25 crore.
• The amount raised from venture capital firms, NRIs and other specific companies is not included in the calculation. The startup’s yearly turnover should not be more than Rs 100 crore in any of the past fiscal years.
• Angel investors can claim 100 % tax exemption on the amount of investment that exceeds the fairs market value. to avail of this exemption, the average income of angel investors should not be more than Rs 25 lakh and should have a net worth of Rs 2 crore in the previous 3 fiscal years.
• Start-ups can claim 100 % tax exemption for period from for three consecutive years the date of incorporation of a business, and it can reap the benefit of a tax holiday for three consecutive years.

Note- The Angel tax is being levied on startups at 30.9% on net investments in excess of the startup company’ Fair Market Value.

Key issues with Angel Tax:-

• Share Valuation- the tax impacted the valuation of share, causing complications for startups in raising funds.
• Discounted Cash Flow Method- Issues arose with the treatment of estimated figures in the DCF method, leading of dispute.
• Scrutiny of funding Sources- Scrutiny of funding sources and investor leading to disputes.
• Retrospective Applications- The retrospective application of the tax and its effect on the conversion of convertible instruments into equity were also significant points of dispute.

How does Angel Tax affect startup? –

• Young startups, already low on funds may struggle with the added tax burden on top of operational costs due to the angel tax.
• Taxing premium above the fair market value of shares can also lead to valuation disputes with tax authorities.
• The extra tax liability can deter investment, stifling the innovation and growth the government seeks to promote.

New major Government’s Initiatives Related to Start-up-

• Mudra Loan Limit: Increased to ₹20 lakh from the current ₹10 lakh for those who have successfully repaid previous loans under the ‘Tarun’ category.
• Anusandhan National Research Foundation: Allocated ₹1 lakh crore, with plans for a fivefold increase over the next decade.
• Space Start-up Venture Fund: ₹1,000 crore venture fund established to support space start-ups.
• National Initiative for Developing and Harnessing Innovations (NIDHI)
• Start-up India Action Plan (SIAP)
• Ranking of states on Support to start-up ecosystems (RSSSE)
• Startup India Seed Fund Schemes (SISFS)

Conclusion-

The removal of the Angel Tax for Investors is a significant step that will strengthen the start-up ecosystem, encouraging more investment and fostering innovation. This change will significantly improve start-up funding sentiment while boosting the morale of deep tech and AI start-ups to take bigger bets. By focusing on skilling and employment the budget creates a favourable environment for tech companies to thrive.