Editor's Note

The Startup Song: Don’t send me an Angel

‘Send Me An Angel’ by Scorpions is a haunting ballad from the 1990s. The song’s emotive lyrics and melodic guitar riffs capture a quest for hope and guidance. Its powerful vocals and atmospheric instrumentation have made it a timeless rock classic.

While the Scorpions sang ‘Send Me An Angel’ and rocked the world, startups in India are singing ‘Don’t Send Me An Angel’ and praying that the Indian government, with the Angel Tax, does not rock their world. This tax imposes levies on investments exceeding fair market value, posing a challenge to fledgling businesses seeking growth and stability.

In recent years, India’s startup ecosystem has shown tremendous growth and potential. However, one of the significant roadblocks that has dampened this progress is the controversial Angel Tax.

The concept of angel tax was introduced by the Finance Act of 2012. According to this legislation, any startup (defined as an unlisted company whose shares are not traded on the stock market) that receives funding from an angel investor must contribute a portion of that investment to the government if certain conditions are met. Specifically, this tax applies when the total investment value exceeds the company’s Fair Market Value (FMV).

When a startup receives an investment greater than its FMV, the excess amount is categorized as “income from other sources” and is subject to taxation. This tax is commonly referred to as angel tax. For instance, if a startup secures Rs 15 crore from an angel investor and the FMV of the shares issued in return is Rs 10 crore, the excess Rs 5 crore is considered taxable income. This excess amount is taxed at a rate of 30.9%.

Example Scenario

To illustrate, let’s consider the following example:

1. *Investment Received:* Rs 15 crore
2. *FMV of Shares Issued:* Rs 10 crore
3. *Excess Amount:* Rs 5 crore (Rs 15 crore – Rs 10 crore)
4. *Tax Rate:* 30.9%

In this case, the Rs 5 crore excess is subject to angel tax, which would amount to Rs 1.545 crore (30.9% of Rs 5 crore).

Operating an early-stage venture often requires substantial funding, which is why startups typically seek investment in exchange for equity. Lacking tangible assets to offer as collateral, these companies rely on angel investors to provide the necessary capital to establish themselves in the market. However, the introduction of the angel tax, as outlined in Section 56(2)(vii)(b) of the Income Tax Act of 1961, added a layer of complexity to this process.

The primary objective behind the implementation of angel tax was to curb money laundering and tax evasion. In India, a significant portion of the population does not comply with tax regulations, and many new businesses fail to maintain accurate financial records or properly report their assets. This creates opportunities for the generation of black money. By taxing excessive share premiums received by private companies, the Income Tax Department aims to address these issues and ensure greater transparency and compliance.

Despite its objectives, the angel tax has faced criticism from the startup community. Many argue that it discourages investment in early-stage ventures and imposes an additional burden on startups that are already struggling to secure funding. The subjective nature of FMV assessments and the complexity of compliance requirements have also been points of contention.

Here are 8 compelling reasons why the Indian government should consider scrapping the Angel Tax for startups.

Encouraging Innovation and Entrepreneurship

Startups are the engines of innovation, driving technological advancements and economic growth. By scrapping the Angel Tax, the government can foster a more conducive environment for entrepreneurs to take risks and innovate without the fear of punitive taxation. This move would likely result in a surge of new ventures and ideas, contributing to a more vibrant and dynamic economy.

Attracting Domestic and Foreign Investment

One of the primary deterrents of the Angel Tax is its impact on investment sentiment. Investors, both domestic and international, are wary of the unpredictable tax implications. Eliminating the Angel Tax would enhance India’s attractiveness as a startup investment destination. This could lead to increased funding, enabling startups to scale and compete globally.

Simplifying the Tax Regime

The complexity and ambiguity surrounding the Angel Tax have created significant compliance challenges for startups and investors alike. By abolishing this tax, the government would simplify the tax regime, reducing the administrative burden on startups. This would allow them to focus on their core business activities rather than navigating complex tax regulations.

Boosting Job Creation

Startups are major job creators, especially in a country like India, which has a burgeoning young workforce. By encouraging investment in startups, the government can stimulate job creation across various sectors. Scrapping the Angel Tax would provide startups with the necessary capital to expand their operations and hire more employees, addressing the critical issue of unemployment.

Promoting Fair Valuation Practices

The Angel Tax has often led to disputes over the fair market valuation of startups. This has created an environment of uncertainty and mistrust between startups and tax authorities. By eliminating the tax, the government can promote fair and transparent valuation practices, encouraging a healthier investment climate.

Aligning with Global Best Practices

Many countries with robust startup ecosystems, such as the United States and Israel, do not have an equivalent to the Angel Tax. By scrapping this tax, India can align itself with global best practices, enhancing its competitiveness on the world stage. This alignment would signal to the global investor community that India is committed to supporting its startup ecosystem.

Enhancing Ease of Doing Business

The Indian government has made significant strides in improving the ease of doing business in the country. However, the Angel Tax remains a stumbling block for startups. Removing this tax would further improve India’s business environment, making it easier for startups to launch and operate successfully.

Supporting Government Initiatives

The Indian government has launched several initiatives, such as Startup India and Make in India, to promote entrepreneurship and innovation. Scrapping the Angel Tax would be a logical extension of these initiatives, providing startups with the financial freedom they need to thrive. It would demonstrate the government’s commitment to nurturing a robust startup ecosystem.

Scrapping the Angel Tax for startups is a necessary step for India to fully realize its potential as a global startup hub. By doing so, the government would encourage innovation, attract investment, simplify the tax regime, boost job creation, promote fair valuation practices, align with global best practices, enhance ease of doing business, and support its entrepreneurial initiatives. The benefits of removing this tax far outweigh its intended purpose, making it an essential policy change for the future of India’s startup ecosystem.

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