Angel Tax Headed for Exit Door? DPIIT Recommends Scrapping Angel Tax

After consultations with the country’s startup ecosystem, the Department for Promotion of Industry and Internal Trade (DPIIT) has urged the elimination of the Angel Tax ahead of Budget 2024.

DPIIT Secretary Rajesh Kumar Singh emphasized the significance of this reform, highlighting its potential to significantly boost capital formation within the country.

"We've consistently recommended the removal of the Angel Tax, based on our ongoing consultations with the startup community," Singh remarked on Thursday.

What is Angel Tax and Why Was it Introduced?

Introduced in 2012 under Section 56(2)(viib) of the Income Tax Act, the Angel Tax was initially conceived as an anti-abuse measure to curb tax evasion practices like money laundering and round-tripping. This tax, exceeding 30%, applies when unlisted companies issue shares to investors at a price above their fair market value. While it initially targeted resident investors, the 2023-24 Budget extended its reach to non-resident investors starting from April 1, 2024.

The provision originally mandated that if an unlisted company, such as a start-up, receives equity investment from a resident that exceeds the face value of its shares, this additional amount would be treated as income for the start-up. Consequently, it would be subject to income tax under the category of ‘Income from other sources’ for that fiscal year.

Following a recent amendment, the government proposed extending this provision to include foreign investors as well. This meant that any funding received by a start-up from a foreign investor would also be considered taxable income.

Startups and Capital Flow: A Strained Relationship

The Angel Tax has been a thorn in the side of the Indian startup community. Industry experts claim that this tax, particularly impactful during the crucial initial stages where many startups rely heavily on foreign funds, can severely restrict the flow of capital, especially during financial strain.

Many experts feel that Angel Tax can significantly impact access to funds for startups facing financial difficulties and also act as a barrier to innovation and ease of doing business.

Exemptions and the Current Landscape

While DPIIT-registered startups are exempt from the Angel Tax, the reality is that only about 1,34,260 startups are registered, leaving a vast majority susceptible to the tax. The Central Board of Direct Taxes (CBDT) attempted to address this by issuing a circular exempting specific investors like sovereign wealth funds and pension funds from 21 countries from the Angel Tax on non-resident investments in unlisted Indian startups.

However, faced with strong opposition from the industry and amidst reports highlighting a decline in funding for start-ups, the Finance Ministry decided to exempt investors from 21 countries, including major economies like the US, UK, and France, from the application of Angel Tax on their investments in unlisted Indian start-ups.

DPIIT's Push and Industry Response

DPIIT's proposal to dismantle the Angel Tax comes after extensive consultations with industry associations and the startup ecosystem.

The Confederation of Indian Industry (CII) also echoed this sentiment in its budget recommendations, stating that the tax's removal "will greatly aid capital formation." This call for repeal has intensified amidst the ongoing funding slump, with investments into startups plummeting to a five-year low in 2023.

Sanjiv Puri, CII President, in the Budget Recommendation, had said, "Taxing early-stage investments stifles innovation and entrepreneurial spirit. Removing this shackle would unleash a wave of capital, propelling the startup ecosystem to new heights."

The industry contends that the government disregards the inherent risk and potential that justify startup valuations. The Finance Act 2023 exacerbated anxieties by extending the tax to foreign investors starting April 2024, further muddying the funding waters for startups.

Experts also opine that scrapping the Angel Tax will accelerate the trend of "reverse flipping," where Indian startups relocate their base back to India, and foster a more innovative environment within the world's third-largest startup economy.

Beyond Angel Tax: A Broader Economic Vision

In addition to the Angel Tax's removal, DPIIT has recommended phasing out inverted duties and reducing high tariffs on inputs within the electronics sector and other industries. These recommendations are part of a comprehensive strategy to bolster India's industrial competitiveness.

Singh acknowledged, "I concur that taxes on inputs should be progressively reduced. Ultimately, the Finance Ministry and Ministry of Electronics and IT (MeitY) will decide on this."

Visa Norms and FDI Liberalization

The government is also contemplating streamlining visa norms for companies operating within the 14 sectors under the Production Linked Incentive (PLI) scheme, facilitating easier movement for investors and skilled professionals. Further Foreign Direct Investment (FDI) liberalization is also on the table to attract more global capital into the country. "This will encompass all companies investing in any of the 14 sectors, irrespective of their PLI scheme participation," Singh elaborated.

A Transformed Startup Landscape?

As Budget 2024 draws near, the DPIIT's recommendations signal a concerted effort to create a more conducive environment for startups and investors in India. The proposed elimination of the Angel Tax, coupled with measures aimed at reducing industrial tariffs and streamlining regulations, has the potential to significantly transform the startup landscape, solidifying India's position as a premier destination for innovation and investment. However, the final call rests with the Union Finance Ministry, which will consider these proposals holistically.

Join Our Thriving Entrepreneurial Community

Follow TICE News on Social Media and create a strong community of Talent, Ideas, Capital, and Entrepreneurship. YouTube  | Linkedin | X (Twitter) | Facebook | News Letters