In her Budget speech, Minister of Finance Nirmala Sitharaman has provided some relief on the issue of ‘angel tax’ that startups face by promising reduced scrutiny. Although this falls short of the call by startups and investors to do away with the tax, it promises clarity.
The tax relates to the difficulty of arriving at the fair market value of startups that issue shares to their investors. Tax officials consider the difference between a lower market value and a higher issue price as income that ought to be taxed. However, typically, most startups make little or no money in the early years of their inception.
“To resolve the so-called angel tax issue, the startups and their investors who file requisite declarations and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuation of shares,” Sitharaman said.
The tax was introduced in 2012 by then Minister of Finance Pranab Mukherjee to tackle the issue of money laundering, but it has come to be seen as the bane of genuine startups. Particularly from 2012 onwards, India’s nascent startup ecosystem has broadened and deepened, holding out the promise of innovative solutions to some of the country’s biggest problems as well as creating jobs.
“Abolish the angel tax for government-recognised startups and SMEs. It's unfair in structure and policy, curbs growth within SMEs, and is largely detrimental to building a world-class startup and SME ecosystem in India,” Shashank Dixit, founder and CEO of Deskera, had told Forbes India prior to the Budget speech.
Sitharaman didn’t go so far as abolishing the tax, but has proposed measures to simplify and slash the scrutiny of startups subjected to the tax demand. The issue of establishing the identity of the investor and source of funds will be resolved by putting in place a mechanism of e-verification “so that there is no man-to-man interface there”, she said.
With this, the funds raised by startups will not require any kind of scrutiny from the income tax department. In addition, special administrative arrangements shall be made by the Central Board of Direct Taxes for pending assessments of startups and redressal of their grievances. It will be ensured that no enquiry or verification of such cases be carried out by the assessing officer without obtaining approval of the supervising officer, “so the element of discretion that startups were suffering has been removed,” the minister added.
At present startups are not required to justify the fair market value of their shares issued to certain investors including category 1 alternative investment funds. Sitharaman has proposed to extend this benefit to category 2 alternative investment funds as well. Therefore, valuation of shares issued to these funds shall be beyond the scope of income tax scrutiny, she said.
The finance minister has also proposed to relax some of the conditions for carry-forward and set-off of losses in the case of startups. She has further proposed to extend the period of exemption of capital gains arising from sale of residential house for investment in startups up to March 31, 2021.