The world of start-ups and investment often comes with complex tax regulations. One such aspect that frequently raises concerns is the enigmatic “angel tax.” While it may sound intriguing, it is crucial to demystify its implications. How does it affect potential investors looking to support start-ups? Let’s delve deeper into the world of angel tax.
Understanding Angel Tax
Start-ups, both listed and unlisted, depend on raising capital to fuel their growth. One common method is offering equity to attract investments. While this investment is a lifeline for start-ups, the government views it as “income” when it surpasses the Fair Market Value (FMV) of the shares.
When unlisted companies raise capital through share issuance that exceeds the FMV of the shares, the government levies income tax on this surplus under the banner of “Angel Tax.” This tax predominantly impacts angel investors supporting start-ups. It is governed by Section 56(2)(viib) of the Income Tax Act, 1961, and was introduced as part of the Finance Act in 2012. Initially, non-resident investors were excluded from its purview. However, amendments in the Finance Act of 2023 extended the scope to include both domestic and foreign investors whose investments exceed the FMV.
Tax Rate and its Impact
The weight of angel tax is substantial, with a hefty 30.6 percent tax rate applied to investments exceeding the fair market value.
Eligibility and Exemptions
Before April 1, 2023, angel tax primarily affected investments by domestic investors in unlisted firms. However, recent changes have broadened its reach to encompass foreign investors. While valuation rules differ for domestic and foreign investors, the amendments introduced exemptions for certain categories of foreign investors. These exemptions encompass government-related investors like central banks, sovereign wealth funds, and global or multilateral organizations, as well as banks and insurance companies. Additionally, investors from specified categories and residents of particular countries, including Australia, Germany, Japan, Korea, the UK, and the US, among others, are also exempt.
The exemptions for companies remain unchanged, with start-ups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) under para 2(iii)(a) eligible for an exemption from angel tax. Companies whose paid-up share capital and share premium do not exceed Rs 25 crore after issuing or proposing shares are also exempt. This essentially means that small-scale angel investors investing under Rs 25 crore are exempt from this tax.
Valuation Methods and Calculation
One might wonder how this tax is calculated. Amendments introduced through the Finance Act of 2023 included new methods for valuing shares, in consultation with stakeholders. In addition to existing methods like the Discounted Cash Flow (DCF) and Net Asset Value (NAV), companies now have five additional methods to calculate share value for foreign investors. These new methods aim to facilitate foreign investments in Indian companies and encourage investors.
Moreover, new regulations allow for price matching between domestic and foreign investors, referencing investments by venture capital and specified funds. The rules also provide valuation methods for determining the fair market value of compulsorily convertible preference shares (CCPS) for investors. Furthermore, the government permits a safe harbor of a 10 percent variation in FMV of shares.
