Clipping The Wings Of Angel Tax

 

2000 startups. 100 meetings. 25 articles. 7 years. 3 WhatsApp groups. 2 whitepapers.

1 unwavering ask:

No More Angel Tax.

This evening, when we first got to see the circular from DPIIT/CBDT that formalized key recommendations suggested with respect to Angel Tax or section 56(2)(viib), we admit our minds went blank for a moment. After all, this one document represents the tireless, collaborative efforts of iSPIRT, the entrepreneurial community of India and ecosystem partners like IVCA, Local Circles, IAN, TiE, 3one4 Capital, Blume Ventures etc., and the proactive support from the government. It has been one relentless outreach initiative that has seen us become a permanent fixture at Udyog Bhavan and North Block (I even checked with the guards regarding the possibility of a season pass). My colleagues Sharad Sharma, TV Mohandas Pai, and partners such as Siddharth Pai, Nikunj Bubna, Sreejith Moolayil, Monika, Ashish Chaturvedi and Sachin Taporia deserve a big shout out for their diligent efforts at connecting with various ecosystem partners and initiating a regular cadence of dialogue with the government.

The key takeaways from the circular are as below

  • Blanket exemption for up to INR 25Cr of capital raised by DIPP registered startups from any sources
  • Amendment in the definition of startups in terms of tenure from 7 to 10 years
  • Increase in the revenue threshold for the definition of startups from INR 25Cr to INR 100 Cr
  • Breaking the barrier for listed company investments by excluding high-traded listed companies and their subsidiaries, with a net-worth above INR 100Cr or a Turnover of 250 cr, from section 56(2)(viib)’s ambit

Each of these points is a major win for the startup community. If one looks at the data from the LocalCircles startup survey in January 2019, nearly 96% of startups that had received notices regarding angel tax, had raised below the permissible limit of INR 10cr. Expansion of this limit to INR 25cr is a huge boost and instantaneously removes thousands of startups from the reach of angel tax. There is an effort here to critically analyse, define and differentiate genuine startups from shell corporations. It includes measures such as increase in the revenue and tenure threshold that will not only help startups with respect to the challenges posed by angel tax but also open up eligibility for benefits under Startup India schemes and policies. We have been talking about the need to encourage and protect domestic investments and the government has paid heed to our concerns by introducing accredited investor norms and by breaking the barrier for listed company investments.

Initiated in 2012 by the UPA government, Section 56(2)(viib) or the “angel tax” section has been a relentless shadow on the entrepreneurial ecosystem. It taxed as income any investment received at a premium by an Indian startup. This provision saw many entrepreneurs clash with the tax officials about the true value of their business and pitted unstoppable entrepreneurial zeal against the immovable tax department.

All of us from the policy team at iSPIRT have been at the forefront of this issue since 2015 when we began petitioning the government to exclude startups from section 56(2)(viib) as taxing investments from Indian sources would cripple the startup ecosystem. We laud the government for appreciating the urgency of the situation and prioritizing this issue.

We first had an inkling of things to come at the February 4th, 2019 meeting held by DPIIT. It was unprecedented as it saw a direct dialogue between government and entrepreneurs wherein both sides could better understand the issues facing each other – how section 56(2)(viib) was hampering founder confidence and how it is a needed tool in the government’s arsenal for combatting the circulation of unaccounted funds.

After this, a smaller working group was constituted on February 9th, to review the proposals made by DPIIT to address this issue, in consultation with the CBDT and the startup ecosystem. iSPIRT were part of both meetings and contributed actively to the discussion.

We can now heave a sigh of relief as we have finally achieved to a large extent what we had set out to do. We finally have a solution that ensures genuine startups will have no reason to fear this income tax provision and the CBDT can continue to use it against those attempting to subvert the law.

This could not have been possible without the help of well-wishers in government departments like Mr Nrpendra Misra, Mr Sanjeev Sanyal, Mr Suresh Prabhu, Mr Ramesh Abhishek, Mr Anil Chaturvedi, Mr Rajesh Kumar Bhoot, Mr Anil Agarwal, who patiently met the iSPIRT policy team and helped develop a feasible solution.

At long last, domestic pools of capital will no longer be disadvantaged as compared to foreign sources. At long last, Indian entrepreneurs will no longer have to fear the questioning of the valuations of their businesses and taxation of capital raised.

Who knows, someday we might have a movie on this. On a more serious note, it is a step that will go down in the chronicles of India’s startup story. This puts the startup engine back on track. More importantly, it shows what can be achieved when citizens and the government get together.

By Nakul Saxena and Siddharth Pai, Policy Experts – iSPIRT

Angel Tax Notification: A Step In The Right Direction, But More Needs To Be Done

There have been some notifications which have come out last week, it is heartening to see that the government is trying to solve the matter. However, this is a partial solution to a much larger problem, the CBDT needs to solve for the basic reason behind the cause of Angel Tax (Section 56(2)(viib)) to be able to give a complete long-term solution to Indian Startups.

While the share capital and share premium limit after the proposed issue of share is till 10 crores and helps startups for their initial fundraising, which is usually in the range of Rs 5-10 Cr. Around 80-85% of the money raised on LetsVenture, AngelList and other platforms by startups is within this range, but the government needs to solve for the remaining 15-20% as startups who are raising further rounds of capital, which is the sign of a growing business, are still exposed to this “angel tax”. Instead, the circular should be amended to state that Section 56(2)(viib) will not apply to capital raises up to Rs 10 Cr every financial year provided that the startups submit the PAN of the investors.

The income criteria of INR 50 lakhs and net worth requirement of INR 2 crores is again a move by the government that requires further consideration for the investing community. Therefore, to further encourage investments by Angels or to introduce new Angels to the ecosystem, there is a need to look towards a reduced income criterion of INR 20 Lakhs or a net worth of INR 1 crore, enabling more investors for a healthier funding environment. We also, need to build a mechanism to facilitate investments by corporates and trusts into the startups.

Most importantly, any startup who has received an assessment order under this section should also be able to for the prescribed remedies and submit this during their appeal. They should not be excluded from this circular since its stated scope is both past and future investments. The CBDT should also state that the tax officers should accept these submissions during the appeals process and take it into consideration during their deliberation.

So, to summarise:

  • Section 56(2)(viib) should not apply to any investment below Rs 10 crore received by a startup per year or increase the share premium limit to Rs 25 Crores, from Indian investors provided that the startup has the PAN of the investors
  • Section 56(2)(viib) should not apply to investors who have registered themselves with DIPP as accredited investors, regardless of the quantum of investment
  • The threshold stated should be either a minimum income of Rs 25 lakhs or a net worth of at least Rs 1 crore
  • Any startup who has received an assessment order should be able to seek recourse under this circular during their appeal

Through this circular, the government has reaffirmed its commitment to promoting entrepreneurship and startups in India. With these suggestions, the spectre of the “angel tax” will end up as a footnote in the history of the Indian startup ecosystem.

We look forward to the early resolution of these pending matters. For any suggestions, Do write to us [email protected]

The article is co-authored with Siddarth Pai, Policy Expert – iSPIRT Foundation and Founding Partner – 3one4 Capital.

Disciplining The Not So Angelic, Angel Tax

If you are an entrepreneur, investor, or simply interested in the start-up sector, then you already know that Angel Tax is the buzzword right now.

Based on a law that was introduced in the 2012 budget by Mr Pranab Mukherjee, the rule aimed to target money laundering through high share premium. But unfortunately, the same provision is today attacking startups for their “high” share premiums and treating the difference between book value and DCF (Discounted Cash Flow) projections as income taxable at 30%. (For those interested in a more in-depth study of the provision and associated rulings can check out this article.

Thus, a law to penalize shell corporations and sham transactions are now being used against startups employing tens of people and generating value for the community.  Valuations are usually based on a startup’s future potential for growth and revenue and using book value, a method that’s better suited to asset-heavy manufacturing industries, is like measuring time in light years – it sounds right but is blatantly inappropriate

Hence the problem. This section hasn’t kept pace with the other anti-laundering and anti-abuse measures instituted by law and has become a blanket provision with little opportunity for a Startup to distinguish itself from a fake business. It also specifically discriminates against domestic investments thereby discouraging both investors and startups from accepting investments from Indian residents.

Latest changes, notified just yesterday, provide some way out for certain startups. However, this is a partial solution to a much larger problem, the CBDT needs to solve for the basic reason behind the cause of Angel Tax to be able to give a complete long-term solution to Indian Startups.

While the share capital and share premium limit after the proposed issue of share is till 10 crores and helps startups for their initial fundraising, which is usually in the range of Rs 5-10 Cr. Around 80-85% of the money raised on LetsVenture, AngelList and other platforms by startups is within this range, but the government needs to solve for the remaining 15-20% as startups who are raising further rounds of capital, which is the sign of a growing business, are still exposed to this “angel tax”. Instead, the circular should be amended to state that section 56(2)(viib) will not apply to capital raises up to Rs 10 Cr every financial year provided that the startups submit the PAN of the investors.

The notification also introduces the concept of an “accredited investor” into the startup ecosystem, which is an acknowledgement of the role that domestic investors play. Globally, an accredited investor tag is given to sophisticated investors investing in risky asset classes to denote that they acknowledge the risks associated with such investments and that they have the financial ability to do so. But instead of fulfilling both criteria of income and net worth, they should follow the global model of fulfilling either criteria and lowering the threshold to 25 lakhs of income or a net worth of Rs 1 crore. Their investment into startups should be excluded from the scope of section 56(2)(viiib). As a process mechanism if the CBDT could put in place a simple once a year mechanism for the Investor to submit his returns and giving him a reference number valid for the financial year, this will enable him to invest in more startups in the year without the need to get permissions every time the investor invests his funds.

Most importantly, any startup who has received an assessment order under this section should also be able to for the prescribed remedies and submit this during their appeal. They should not be excluded from this circular since its stated scope is both past and future investments. The CBDT should also state that the tax officers should accept these submissions during the appeals process and take it into consideration during their deliberation.

So, to summarise:

  • The angel tax should not apply to any investment below Rs 10 crore received by a startup per year, from Indian investors provided that the startup has the PAN of the investors
  • The angel tax should not apply to investors who have registered themselves with DIPP as accredited investors, regardless of the quantum of investment
  • The threshold stated should be either a minimum income of Rs 25 lakhs or a net worth of at least Rs 1 crore
  • Any startup who has received an assessment order should be able to seek recourse under this circular during their appeal

Through this circular, DIPP has reaffirmed its commitment to promoting entrepreneurship and startups in India. With these suggestions, the spectre of the “angel tax” will end up as a footnote in the history of the Indian startup ecosystem. We look forward to these pending matters

Start up India, Stand up India.

The post is authored by our policy experts, Nakul Saxena and Siddarth Pai.

White Paper On The Analysis Of High Share Premium Amongst Startups In India

“High share premium is not the basis of a high valuation but the outcome of valid business decisions. This new whitepaper by our iSPIRT policy experts highlights how share premia is a consequence of valid business decisions, why 56(2)(viib) is only for unaccounted funds and measures to prevent valid companies from being aggrieved by it”

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.

Stay-In-India Checklist – Successes So Far And The Path Forward

Over the past few months, we have witnessed a number of policy changes focused on creating a conducive environment for startups and entrepreneurship in India. Some changes go beyond the startup ecosystem and attempt to resolve the issues faced by companies/investors in general. A common feature in most such changes is iSPIRT’s Stay-in-India Checklist (SIIC). The SIIC comprises 34 issues, which were extracted from a larger list of 120+ issues, put together by the iSPIRT team after extensive consultation with various stakeholders.

With the 29th June notification of the MCA amending the Deposit Rules, a total of 29 SIIC issues have been addresses/acknowledged by various government departments. Some of the key changes that have taken place pursuant to SIIC are as follows:

  • Angel tax: Monies received by a company from certain resident investors (including angel investors) which are in excess of the fair market value of shares issued against such monies, are taxed as income in the hands of such company. This leads to significant hurdles in domestic angel investments (other popular modes of investments are exempted from this tax). Now, startups that are approved by the inter-ministerial board formed by DIPP (“Approved Startups”) have been exempted from this requirement.
  • Harmonisation of tax policy for listed and unlisted equity instruments: There is unnecessary disparity between holding periods for listed and unlisted shares for claiming long term capital gains benefit in relation to them. While the holding period for listed shares is only 12 months, for unlisted shares, it was 36 months. This, despite the fact that investment in unlisted shares, such as those of startups, carry higher risk. Now, this period has been reduced to 24 months. This relaxation is available to all companies, irrespective of them being startups.
  • Favourable tax regime for IPR: In the past several years, India has experienced that the ownership of IPR created in India does not reside in India, as tax regime for IPR in other jurisdictions is more favourable. Now, income by way of royalty in respect of a patent developed and registered in India will be taxed at 10%. This relaxation is available to all companies, irrespective of them being startups.
  • Convertible notes: One of the most popular instruments abroad for startups to raise early stage funds, convertible note, is not expressly recognised in India, and could be considered to be a form of ‘deposit’ which can be taken by a company only from its existing shareholders/ directors. Now, convertible notes of up to INR 25 lakhs per person have been permitted for startups that have registered on the StartupIndia portal (“Registered Startups”).
  • Indemnity escrows and deferred consideration: In FDI transactions, use of escrow mechanisms for indemnity arrangements and payment of deferred consideration required prior approval of the RBI. This created significant hurdles in acquisition of Indian companies by non-residents (since these terms are standard in acquisition transactions globally, and all acquires expected them in Indian acquisitions as well). Now, these mechanisms have been permitted for a period of up to 18 months and for an amount of up to 25% of the consideration under the automatic route (without the prior approval of the RBI). This relaxation is available to all companies, irrespective of them being startups.
  • Transfer from FVCI to non-resident: There is uncertainty around the transfer of shares of an Indian company by an FVCI entity to a non-resident entity. While certain custodians allow such a transfer without an approval of the RBI, other custodians require prior approval of the RBI before proceeding with such transfer. Although there is no specific regulation that requires FVCI entities to obtain prior approval of the RBI for such transfers, given the aforesaid difference of opinion among custodian (which results in delays in M&A transactions), there was a need for the RBI to clarify this issue. Now, Registered Startups have been exempted from this requirement.
  • Restriction on FVCIs from investing in all sectors: Foreign venture capital investors (FVCIs) are permitted to invest in only certain specified sectors. This is largely owing to the list of permitted sectors set out in registration certificates issued by authorities to FVCIs. Now, FVCIs are permitted to invest in all Registered Startups, regardless of the sectors they have been engaged in.

In addition to the above, the following issues have also been recognised by various government departments. The changes to resolve these issues have either been notified, or have been announced to be notified in due course:

  • Collection of foreign monies by residents in India on behalf of non-residents
  • Online filing of forms for cross border transactions
  • Simplification of incorporation process
  • Share swaps in FDI transactions
  • Venture debt not be categorised as deposits
  • Acquisition of overseas company with an existing subsidiary in India
  • Foreign subsidiaries of Indian companies investing back into India
  • Relaxation of external commercial borrowing guidelines for startups
  • Simplifying process of conversion of LLP into a company
  • Exclusion of private companies from the term ‘listed company’
  • Grant of ESOPs to promoters and independent directors
  • Single window agency for closure of failed startups
  • Permitting outbound mergers
  • Simplifying the process of private placement
  • Applicability of provisions relating to insider trading on private companies

As one would note, a significant number of material issues have either been addressed or are in advanced stage of being addressed. iSPIRT continues to interact with the government to get further relaxations on these issues, as some relaxations are restricted only to Approved Startups or Recognised Startup, or are simply limited in scope. iSPIRT also continues to push for resolution of other issues which have either not been addressed so far or are new and have not been covered in SIIC.