BAJAJ BROKING
July 16, 2024
6 mins read
For many years now, startups in India have been bearing the brunt of something called “angel tax.” This tax is imposed when unlisted entities (usually startups) raise funds and the valuation of such entities exceeds their fair market value or FMV.
The reason startups are finding it difficult to survive this “killer” angel clause is plain and simple. In the initial years, any business needs capital. Even startups need capital. They need such capital to grow, stay afloat, invest, and pay their expenses.
As per many experts, startups end up paying 30% angel tax. If they have to part away with 30% of the capital due to a certain tax, it can threaten their existence. Typically, tax is levied on the profit earned from the day-to-day activities of a business.
Most startups struggle to make a profit in their initial years; some don’t even have enough cash inflows to pay their basic expenses. In such a situation, if they have to pay a 30% angel tax to the government, it can be extremely discouraging.
Startups are a bit like adolescents who must be groomed to become adults (in this case mature companies). The government can play a key role in grooming them. Therefore, many top industrialists have urged the government to remove the angel tax in this budget.
Moreover, the Department for Promotion of Industry and Internal Trade (DPIIT) has also suggested the government to eliminate the angel tax on startups.
If you’re still struggling to understand what angel tax is and how it affects Indian startups, read this blog because it simplifies this whole issue, which can be complex to understand. At Bajaj Broking, we do believe that BudgetSimpleHai and therefore we’re decoding all complex issues for you.
According to reports, Finance Minister Nirmala Sitharaman will present the 2024 Union Budget on 23rd July. This Budget is expected to have announcements on policies, schemes, income tax rate slabs, and more that are likely to affect everything around us.
To simplify this year’s Budget and to decode its impact on your life, your investment portfolio, and all that you do, we bring you #BudgetSimpleHai! Join us on our website or head over to any of our social handles to get the latest updates on the Union Budget as it happens.
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When an unlisted company raises capital by issuing shares to investors, angel tax comes into the picture. While it is called “angel tax,” it has created something of a crisis for startups in India. Let’s understand how.
Suppose a startup is trying to raise capital. It manages to get some investments at a certain valuation, which is higher than the fair market value (FMV) of that startup. In this case, the excess amount thus received by the startup is considered as income and therefore is subject to angel tax. It is called “angel tax” because it mainly affects angel investors.
There are several issues with this tax. First, if startups (which are anyway under considerable pressure to raise capital and survive) have to pay a portion of the money they raise as tax, it can badly affect their existence.
Second, many experts have said that startups face an angel tax of a whopping 30% when the investments they receive are more than their FMV. Third, FMV is a subjective number which is based on many assumptions about how a startup will perform in the future.
Due to all these reasons, angel tax has adversely affected early-stage investments in startups and several industry lobbies have requested the government to look into this matter. Having understood what angel tax is, let’s delve deeper into this topic.
Angel tax has been around for 12 years in India. The intention behind the tax was to curb money laundering. However, over the years, it has emerged as a major hindrance for startups when they try to raise capital.
In reality, angel tax ends up taxing genuine investments in startups. Even though the government has made efforts to look into this issue, it remains unresolved. What is particularly surprising is that angel tax does not exist in any other country apart from India.
The whole thing becomes even more surprising when we consider that we already have Section 68 of the tax act which is aimed at addressing funding sources that cannot be explained.
Due to these reasons, the industry wants the angel tax to be totally eliminated by the government. It must also be kept in mind that startups in India are already under a lot of pressure due to high taxes and compliance expenses.
On top of it, they have to deal with angel tax. This particularly affects early-stage investments, which are crucial for startups to grow. Therefore, several industry leaders have urged the government to do away with the angel tax in the Union Budget 2024.
The central government certainly wants to help startups. That’s why it has programs like the Atal Innovation Mission, Startup India, and the National Strategy for Artificial Intelligence.
Besides, startups have also created several jobs and contributed to the economy. Therefore, it seems that angel tax will be a major talking point of the Union Budget 2024.
This question becomes especially relevant when we consider that the DPIIT has already recommended the government to remove the angel tax on startups.
It’s also believed that the finance ministry, which is in charge of preparing the Union Budget, will be looking into this matter. This shows that the authorities at the senior-most level consider this issue to be extremely serious.
It’s tough to answer whether the Budget 2024 will save Indian startups from this “killer” angel, especially if we look at the recent history. Before FY 2023-24, angel tax was applicable only to local investors, which means foreign investors were excluded from it.
However, Budget 2023 increased the scope of this tax and brought even foreign investments into its ambit. If the government has tried to widen the scope of angel tax in the last year, it remains to be seen whether it will eliminate angel tax this year.
Meanwhile, apex industry bodies and associations have appealed to the government to do away with angel tax. The Confederation of Indian Industry (CII) has recommended the government to remove the angel tax while submitting its expectations from Budget 2024.
Prominent industrialists, like the co-founder of Infosys S “Kris” Gopalakrishnan, have said that the government must look into this matter to give a boost to startups. Therefore, when Sitharaman presents the budget on July 23, startups and angel investors in India will be very curious to see whether she saves them from the so-called angel tax.
The fact that DPIIT has appealed to the government to eliminate the angel tax on Indian startups shows that there is a possibility of it happening. If the budget actually removes the angel tax, it will be a big boost for startups and angel investors in India.
Many startups are in the next stage in the country. They have already provided jobs to many people and built a reputation for themselves not just in India but worldwide. If the government rationalises the tax structure for them, it will show that the government is not only encouraging startups but also giving a boost to innovation and job creation.
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The “Killer” Angel Clause impacts startups by making them pay a whopping tax when they get investments at a valuation higher than their fair market value. As most startups are in the initial stage, they find it very difficult to pay angel tax.
Budget 2024 may impact the startup ecosystem favourably by making provisions so that startups can access domestic capital easily. If local institutions can invest in startups with ease, it will give them a big boost.
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