New mandate under the angel tax regime has gotten VCs and startups worried
The new tax provisions have gotten startups and VCs worried as the government has tightened the noose in regards with foreign funding as the funding has not flown in as much as it should have to help the startup ecosystem grow more. This monetary crunch of funding has also led to layoffs in a huge number and were conducted by several big giant technology companies.
On 31st January, the annual Economic Survey by the Indian government reported that several Indian startups have their headquarters registered in other countries and to bring a reform the government has suggested changes in the tax regimes and in the flow of capital by regulating it so that the young entrepreneurs would want to move back to India for their businesses.
Under the new tax regime, the government has mandated that the angel tax regime, from now on, is applied to the flow of capital into Indian startups from abroad. What did the angel tax regime include previously and what is the current mandate? The angel tax was started in 2012 as a medium to prevent money laundering. The mandate for the tax regime at that time was, that startups who have raised funds from angel investors could be taxed whenever the round of funding happens at a valuation more than the fair value of shares.
The premium paid by investors which is about 31%, is treated as income by the Tax authorities. As years passed, several startups and investors have expressed being troubled by Tax authorities because of the same provision even if the capital raised is 100% genuine. Startups have received tax notices on the angel investments they have received 3 to 4 years prior. The late fees, if exceeded crossed the capital also which was raised.
According to a survey conducted by LocalCircles in 2019 which reported that 73 plus startups who had bagged funding from angel investors amounting between Rs 50 lakh to Rs 2 crore in India ended up getting a notice from the income tax department.
What does the new tax regime look like?
Until now, funding from two classes of startup investors was exempted from the angel tax regime. VC firms are mostly registered as alternative investment funds in India, along with all foreign investors. Considering 90% of the investments in startups come from foreign sources, under the new Tax regime brought out in the AmrtiKal budget of 2023, the Indian government has pulled out the exemption for foreign investors.
Siddharth Pai, Managing Partner of VC 30ne4 Capital, said, “It will be an impediment for some of the biggest foreign investors in Indian startups. An analysis of the funding rounds from 2022 and 2021 shows Indian investment at low single digits in these rounds. Placing these restrictions on foreign capital without any exceptions will be detrimental to startup funding.”
This new angel tax which has led startups and VCs to get worked, while the bureaucrats made it clear publicly that it would not apply to DPIIT-registered startups; however, it is yet to be seen if it applies to all 84,000 or so young companies or just the top 1% of them. Startups will be unable to contribute to the ESPO trust if they are unable to make salary advances, engage in stick M&A, or establish subsidiaries as a result of the new mandate.
Venture capital firms are waiting on the government to change the new mandate and want the Finance Ministry to issue a clarification on the issue that VC funds based in foreign jurisdictions are exempt from the new mandate.
