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Angel Tax
Context:
Confederation of Indian Industry seeks removal of ‘Angel Tax’ to greatly aid capital formation.
More on News:
- Angel Tax was first introduced in 2012 to deter the generation and use of unaccounted money through the subscription of shares of a closely held company at a value that is higher than the fair market value of the firm’s shares.
- The Finance Act 2023 modified the angel tax provisions amid a severe funding crisis in 2023, which saw over 100 Indian startups lay off more than 15,000 employees, following a prolonged funding winter that started in 2022.
Angel tax:
- It refers to the taxation levied on the excess premium that angel investors pay while investing in startups.
- When startups receive funding from angel investors or high-net-worth individuals (HNIs), they often issue shares to these investors at a premium, which is higher than the face value of the shares. This premium reflects the potential and growth prospects of the startup.
- Under Section 56(2)(viib) of the Income Tax Act, 1961: If the premium on these shares is considered excessive, then the amount exceeding the fair market value of the shares is deemed as “income from other sources” and taxed as per the applicable income tax rates.
- Earlier, it was imposed only on investments made by a resident investor.
- However, the Finance Act 2023 proposed to extend Angel Tax even to non-resident investors from April 1, 2024.
Impact of Angel tax:
The imposition of angel tax has a significant impact on startups, particularly those in the early stages of development with limited revenues:
- Cash Flow Constraints: The angel tax creates cash flow constraints for startups, which rely on funds to fuel their growth and operations.
- Fair Market Value Challenges: Determining the fair market value of a startup, especially in its early stages, is challenging due to limited financial data.
- Uncertainty and Apprehension: Among angel investors and high net worth individuals (HNIs), discouraging them from investing in startups.
- Competitive Disadvantage: Indian startups face a competitive disadvantage compared to their global counterparts, as foreign startups do not have a similar tax burden.
- Tax Compliance Over Innovation: High tax liabilities divert the focus of startup founders from innovation and business growth to tax compliance, paperwork, and legal complexities.
- Difference Between Angel Investor and Venture Capitalist:
