Angel Tax, a tax levied on start-ups that receive funding from angel investors in India, was introduced in 2012 as a measure to deter money laundering and curb the use of illicit funds in the start-up ecosystem. 

However, the tax policy drew flak from various quarters due to its perceived indiscriminate application. Many complained that it created unnecessary impediments for start-ups trying to raise capital and angel investors who are keen on backing these entities. 

In 2015, this tax rate was raised from 20 per cent to 30 per cent, further exacerbating the burden on start-ups and investors. In response to the criticism, the government introduced some exemptions and reliefs, such as relaxing the tax for start-ups that met specific criteria. 

In 2019, the government revised the angel tax policy again, increasing the minimum turnover threshold for exemption from Rs 25 crore to Rs 100 crore and exempting investments made by non-residents from the tax. 

The government also introduced a mechanism for start-ups to obtain a certificate of exemption from the tax, subject to certain conditions. Despite these changes, the angel tax remains a contentious issue in India, with many stakeholders calling for its complete removal.

What Changed In 2023

The proposed change in the Finance Bill of 2023 would extend the scope of Section 56 (2) (viib) of the Income Tax Act, commonly referred to as the ‘Angel tax’, to include non-resident investors in unlisted companies. The amendment, therefore, entails the removal of exemptions for foreign funds and non-resident investors who will be subjected to a tax on the difference between the capital raised and the fair value of securities sold. 

This change may have a detrimental effect on the influx of foreign investments into Indian start-ups. There is also a possibility that the government believes that foreign funds may set up alternate investment funds (AIFs) in Gift City as per the Securities and Exchange Bureau of India (SEBI) guidelines. 

That said, global investors may also pressure start-ups to move overseas and invest in these funds, meaning start-ups may domicile overseas. This is unless the government announces further exemptions under the proposed angel tax, which we will know in the coming days.

Conditions Of Exemption

The primary prerequisite for the exemption entails that the cumulative sum of the start-up’s paid-up share capital and share premium, after the issuance or proposed issuance of shares, shall not surpass Rs 25 crores. This stipulation grants a reprieve to resident angel investors who contribute modest sums from the obligation to pay taxes. 

Additionally, the start-up must be acknowledged by the Department for Promotion of Industry and Internal Trade (DPIIT) under para 2 (iii)(a). The exemption persists for start-ups, provided that the total amount for the transaction remains below Rs 25 crores. 

Notably, domestic non-AIF that invest in Indian start-ups are still liable to pay a tax on their transactions. Importantly, the exemption previously available to foreign investors will be affected. This includes any offshore fund investing in India, as foreign investments will now be subject to the angel tax.

Angel Tax Sports A Devilish Halo

India has emerged as a distinguished hub for start-ups globally and is the third largest start-up ecosystem globally. However, the ongoing funding winter has hit the sector hard, with many founders struggling to raise capital. 

According to Tracxn Technologies, in February 2023, the country’s start-up ecosystem saw only 91 deals worth $1.32 billion, against 308 deals worth $4.77 billion in the year-ago period.

The imposition of angel tax scrutiny is perceived as unnecessary and perilous by thought leaders for the financial well-being of their ventures. 

Therefore, the postponement of this taxation policy has become a matter of paramount importance, as it can offer much-needed respite to start-ups and angel investors, facilitating the procurement of capital more efficiently. This tax deferral has the potential to attract greater investments to start-ups, thus promoting job creation and bolstering the country's overall economic growth. 

Furthermore, it can incentivise more angel investors to support start-ups, resulting in enhanced innovation and competitiveness in the market. Notably, deferring the angel tax on non-residents is particularly critical, as it can stimulate foreign investment in Indian start-ups. 

Given the intricacies and ambiguities of the current tax laws, including the Angel tax, non-resident investors may exhibit reluctance towards investing in Indian start-ups. However, by postponing the tax, non-resident investors may be inclined to invest in these ventures, providing a fillip to the country’s economy and empowering start-ups to realize their growth potential.

-- Gaurav VK Singhvi, co-founder, We Founder of Circle