Startup FDI: Angel Tax Exemption; Which Countries Are Exempted?

The government has relaxed the Angel Tax Rules for Non-Resident Investments, which could potentially provide relief for startups seeking funds from foreign countries. Non-resident investors from 21 countries and sovereignties, including the US and Japan, have been exempted from the angel tax.

Which Are The Countries Exempted From Angel Tax?

In a notification, the Central Board of Direct Taxes (CBDT) has said that the non-resident investments into privately-held Indian startups from 21 countries, including the US, the UK, Germany and France, will not attract angel tax.

The 21 countries are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US.

CBDT on May 24 notified classes of investors, who would not come under the angel tax provision. Excluded entities include those registered with Sebi as category-I FPI, endowment funds, pension funds and broad-based pooled investment vehicles, which are residents of 21 specified nations, including the US, UK, Australia, Germany and Spain. 

The CBDT notification comes into effect on April 1.

Last week, the government had also proposed a host of changes to tax levied on angel investors in unlisted entities, including expanding the scope of valuation methodologies.

What Worries the Startups?

The list of 21 countries exempted by the government for the levy of Angel Tax excludes key countries like Singapore, Netherlands and Mauritius where major chunk of Venture Capitalist firms set up their funds to avoid attracting angel tax on their Indian investments.

The data from the Department of Promotion of Industry and Internal Trade (DPIIT), reveals that Mauritius, Singapore and the Cayman Islands are among the top 10 countries with the highest foreign direct investment (FDI) in India.

According to the DPIIT Data the top 10 investing countries in India are:

According to the DPIIT data, the FDI inflow from Singapore stood at USD 13.08 Billion during April-December 2022, while Mauritius was USD 4.73 Billion during the same time. The FDI inflow also includes the amount invested in securities that don’t attract angel tax.

The startups are worried that because of the exclusion of these countries, the inflow of capital into the country from these destinations will get impacted. It will encourage the flipping of companies outside India and add more compliance burden on startups as well as investors. 

What is Angel Tax & How Is It Applied on Non-Resident Investors?

Angel Tax refers to a tax levied on investments made by angel investors in startups or small and medium enterprises to prevent money laundering through the issue of shares at a premium valuation. However, it ended up discouraging angel investors and startups as heavy taxation and regulatory scrutiny were applied. Changes have since been made to ease the burden on startups and angel investors.

The imposition of Angel Tax on startups has been a topic of much debate recently. Previously, only investments made by Indian residents were subject to the tax, but the Finance Bill of 2023 has expanded its scope to include non-resident investors. This tax grants excessive power to officials and is contradictory to the objective of promoting a thriving startup ecosystem.

The angel tax is applied based on Section 56 (2) (VIIIb) of the Income Tax Act, as notified earlier this year. According to the provision, any difference between the fair market value and the face value of shares issued by a company is taxed.

The government had in the Budget expanded scope of the angel tax to include investment from foreign investors. The startups which have been struggling to receive funds amid funding winters, have been seeking exemption for certain overseas investor classes.