Angel Tax – Is Foreign Funding Tap Getting Dry?

Angel Tax is in the news again. Why is this so much of a concern to Government, founders, and investors, so much so that it keeps hogging the limelight and causes sleepless nights for the founders. 

Let me explain. 

All startups want to get funded. When founders want the valuation of their venture high and investor as low as possible, that balance is market driven, based on demand and supply and inherent strength of the venture. Right? Wrong.

What is Fair Market Value (FMV) in founder’s and investor’s eye, may not be FMV in Government’s eye. They have deputed merchant bankers and Valuers to arrive at fair market value, basis their assessment FMV is settled. However, there are also cases, when valuer’s valuation figures are also disputed by Income Tax Authorities. Why does Government is so skeptical?

Unfair Advantage: The Impact of Valuation Discrepancies

Take for example, a venture’s FMV is Rs 100 and it takes money from investor at Rs 1000, the difference of Rs 900 that startup does not deserve, it spends on expense heads benefiting indirectly the investor’s case in India. This could be also for activities that is not pure business and that’s why government. is too strict on NGO sources of funds. This unfair additional Rs 900 is what Government wants to tax as income. 

Extending Scrutiny: Foreign Investors Now Subject to Angel Tax

So far, Angel Tax was only applicable on Indian resident investors. Government has notified an amendment on 24th May 2023, to put foreign investors at par with domestic investor, retrospectively from 1 April 2023, thus making their investment subject to scrutiny and tax under Angel tax. Will that not strangulate the foreign investments in Indian startups, when 85% of the investments are from abroad? 

Exemptions and Exceptions: Categories of Foreign Investors

However, certain categories of foreign investors are exempted from angel tax provisions. These are Government and related investors such as sovereign funds, pension funds, direct or indirect holding of 75% or more of that Government etc banks or regulated bodies in insurance, SEBI Category 1 FPI, Endowment funds with academic / medical / charitable institutions, Broad based pooled investment Fund with more than 50 investors. Indian startups registered with DPIIT and recognized as Start-ups continues to be exempted from angel tax.

Industry Representation: Challenges and Implications Discussed

People like Subramaniam Krishnan, Partner EY, Padmaja Ruparel, IAN Fund and Industry made a representation to the Government to appraise them of the challenges from the new notification and implications from it. Government has floated a draft paper for public opinion to make amendment. Here are some.

New Valuation Methods: Introducing Additional Complexity

New notification mentions of five new valuation methods, only applicable when invested by non-residents. These are a) Comparable Company Multiple Method b) Probability Weighted Expected Return Method c) Option Pricing Method d) Milestone Analysis Method and e) Replacement Cost Method. These are in addition to two prevalent for resident and non-resident investors – NPV and DCF. By providing non-residents with additional valuation methods, which would be FMV for investment into a single venture during the 90 days window investment round, when resident and non-residents invest with different valuation methods and different valuation? It will lead to further dispute.

Safe Harbour Clause: Debating the Premium for Non-Financial Leverages

Government has agreed to a clause of Safe Harbour of 10% for valuation of equity shares. It means investment can take place within an investment round at 10% variance to the valuation, due to factors such as commercials, anti-dilution rounds, future re-organizations etc. This is too thin a premium for additional non-financial leverages that investors take and should be 25%. 

Striking a Balance: Treating Non-Residents at Par Without Hindering Innovation

Most of the investment in India comes from Singapore, Netherlands, Mauritius etc due to preferential tax treatment there. Government’s fear of round-tripping classified these countries not on exemption list of countries for Angel Tax. 

Angel tax exemption applies for investment that originates from USA, UK, France, Austria, Canada, Czech Republic, Belgium, Finland, Israel, Iceland, Japan, Korea, Russia, Norway, New Zealand, and Sweden. What is a fear, should not be blanket restrictive. Dual country treaty signed with Mauritius and Singapore should provide for such exchange of data to identify fictitious from the genuine. 

It is welcome to treat non-residents at par with resident investors. However, torchbearer of India’s growth and innovation should not be gasping for investment. 

About The Author: Ashish Jain is the CEO of The Startup Board. Ashish is on a mission to enhance the success ration for the startups from current 10% to 20% by 2025. He helps Founders with corporate connect for revenue. He mentors on go-to-market strategy and overcoming execution challenges.