Investment above Fair Market Value – no more Angel tax for Startups

In this session we take up a long pending issue of “Angel Tax”. It has been given partial reprieve recently, under StartupIndia plan. We also discuss how startups can raise money from Angels, without getting trapped in fair market value rule of finance act 2012.

Sanjay Khan speaks on the problem, the latest announcement and the way out for startups to raise equity without DIPP route, in the below given google hangout video.

What is this issue of Angel Tax? And what changes after new announcement?

Startups receive equity infusions from various sources. One of the most lucrative and internationally prevalent source is the Individual investor (Angels).

In India income tax department is skeptical about angel investment. This is because, at times angel investment was misused to channelize black money. Artificial valuations is mostly the doubt in mind of income tax authorities.

As per, Finance Act 2012, capital raised by an unlisted company from any individual against an issue of shares in excess of fair market value would be taxable as ‘income from other sources’ under Sec 56 (2) of the I-T Act. This came to be popularly called as angel tax.

So, if fair market value is say e.g. Rs. 10 per share and a startup receives Rs. 15 investment from an Angel investor. Income tax treats this difference i.e. Rs. 5 per share, as income.

As per the above provisions, the angel investments are subject to assessing officer’s approval. The jurisdictional assessing officers of income tax enjoy the discretionary powers. Instances of misuse of these discretionary powers by assessing officers created problems for startups.

Many startups are not serious about the documentation. Mostly, such startups get into problems due to lack of documentary evidence about their valuations.

Govt. of India recently announced a change under StartupIndia policy of DIPP. A Central Board of Direct Taxes notification, dated June 14, made the required changes to Section 56(2)(viib) of the Income-Tax Act, exempting startups raising funds from angel investors. This is limited to the startups approved by DIPP.

Is it available to all DIPP registered startups?

No, not to all startups approved or recognised by DIPP.

There are three kinds of startups now.

(a) General Startups, that have not applied to DIPP or are not even eligible to apply to DIPP.

(b) those who applied and got recognised by DIPP but did not apply for Income tax exemption.

(c) those who fall under (b) and also got the income tax exemption approval of the inter ministerial board of DIPP.

Only the third (c) category of startups are eligible. These startups need not worry about the assessing officer discretion now. The benefit is available so long as they enjoy the income tax exemption under startup policy.

So, if this is not applicable to all startups, does it mean other startups cannot raise equity from Angel investors at all?

The Finance act 2012 provision does not bar angel investments. Startups not under (c) above can raise the investment from Angels (individual investors). The limitation is that the valuations in such cases will  be subject to examination by assessing officer approval.  They have to extra careful about the valuation at each round of funding.

Such startups should get a professional third party valuation reports. Get a valuation reports for all rounds of valuations with proper documentary proofs. You can face the assessing officers with proper documents without any fear.

The recent hype created in media was mainly arising from down rounds. That is when the new round of investment was done at a lower rate than the previous round. This led to income tax doubting the misuse.

In such challenging valuation situations like down round valuations, the startup can get a professional third party valuation from 2 or 3 sources. This way they can deter the assessing officer’s misuse of discretionary power as well as stand any litigation test, if put through.

In essence, a startup can raise honest angel investment at right fair market value. A professional valuation exercise with all objectivity can help you cover the risk.

iSPIRT’ stand

Startups ecosystems in developed countries enjoy a favourable investment climate that proactively promote and protect the angel’s investments.

Government of India should show give clear signal of favourable investment climate in the country.

Government of India should think of measures that can deter black money getting invested in the Startups, instead of doubting each and every investment. For this Govt. should repeal the the provision introduced by finance bill 2012 should. Discretion to assessing officer is not serving the cause of building investment climate.

India seriously needs a policy that promotes angel investments in general, with responsibility of money invested taken by investors rather than Startups.

Access to the most vital funds for early stage startups

Angel funds are the most vital funds for any startup. It does not only help in validating the idea and prevents the early startup death, but also brings in the valuable mentoring to the table. Having the first right angel investor to back you in your startup journey sets the tone for more investments to come for the startup’s growth. At the high-risk stage (early stage), angel investors on board help sail through the ups and downs of the entrepreneurial journey.

2014 was a defining year for Indian startup ecosystem. The year saw the highest-ever inflow of angel and seed funds in India. According to VCCEdge (a platform which provides information about the Indian deals landscape), $115 million was raised by entrepreneurs through angels and seed funds across 285 deals, compared to $69 million in 2013 across 262 deals. In the last two years, LetsVenture ( an online platform for angel funding) closed 23 deals on the platform with $6.5 million being raised. The very interesting trend to note across these deals was that out of the 170 angels who invested online, 40% of them were first-time angel investors. It’s so encouraging to see senior professionals and successful entrepreneurs joining the startup investment bandwagon.

India, as a country, to grow economically needs many successful startups. And to reduce the high mortality rate among startups at early stage, we need thousands of angel investors in our startup ecosystem. Though Indian startups raised nearly $ 5 billion from venture funds and angel investors last year, a large number of young startups still find it difficult to access capital and mentors. Also, we have seen entrepreneurs falling into the traps by raising funds from investors who don’t have any idea of the startup ecosystem. These startups are forced to give a high equity for a small capital and subsequently face trouble in the future fund rounds. Also, there is a major Series A crunch in the ecosystem. Hence, there is a dire need of mentors and advisors who can help startups to be Series A -ready.

LetsIgniteKeeping in mind the absence of an opportunity to network with reputed angels,VCs and mentors for early stage startups, LetsVenture is coming up with the biggest Angel Summit for smart entrepreneurs, investors and mentors – LetsIgnite on April 21-22, 2015. There is a ‘Startup Competition’ to choose 100 best startups for the opportunity to meet the best Angels, VCs and mentors from India and abroad on a single platform. The competition is open for startups who are actively fundraising, looking for fundraising in near future and those who are looking for right mentors and advisors. More information about this competition can be found here. Last date for receiving applications is 20 March, 2015.

Post Contributed by Niti Shree, LetsVenture