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Will Selectively Exempting 21 Nations From Angel Tax Net Truly Help The Start-Up Sector?

Questions arise why countries like Singapore, Mauritius and the United Arab Emirates, which account for a majority of inbound foreign direct investment, are missing from CBDT’s notification

Will Selectively Exempting 21 Nations From Angel Tax Net Truly Help The Start-Up Sector?
POSTED ON May 26, 2023 4:35 PM

The Finance Ministry notified 21 nations from where non-resident investment in unlisted Indian start-ups will not attract angel tax, yesterday. This list included investments from the US, the UK, France, Australia, Germany, Spain, Austria, Canada, the Czech Republic, Belgium, Denmark, Finland, Israel, Italy, Iceland, Japan, Korea, Russia, Norway, New Zealand and Sweden.

Strangely, the same list excludes Singapore, Mauritius, the United Arab Emirates (UAE) and the Netherlands, nations where Indian start-ups derive plenty of investment from.

This selective exclusion has left many in the start-up sector perplexed. 

Section 56(2)(viib) of the Income Tax (IT) Act, commonly referred to as angel tax, has been a long-standing concern for start-ups in India.

Under this provision, funds raised by start-ups at a valuation higher than their 'fair market value' (FMV) were treated as income and subjected to taxation. 

Moreover, angel tax was earlier only applicable to resident investors. The 2023–24 Budget introduced provisions to extend it to non-resident investors as well from April 1, 2024, bringing overseas investment in unlisted held companies, except the Department for Promotion of Industry and Internal Trade (DPIIT) recognised start-ups, under the angel tax net.

Punit Shah, partner at tax firm Dhruva Advisors
Punit Shah, partner at tax firm Dhruva Advisors

However, this classification led to several challenges for start-ups, including unnecessary scrutiny, lengthy assessments and cash flow issues. Many founders and investors complained that it also impeded the growth and investment climate for start-ups in the country and sought exemption for certain overseas investor classes.

On 24th May, the Central Board of Direct Taxes (CBDT) notified classes of investors who would not come under the angel tax provision. This included those registered with the Securities and Exchange Board of India (SEBI) as Category-I FPI, endowment funds, pension funds and broad-based pooled investment vehicles, residents of the 21 specified nations.

While welcoming the relaxation to ease foreign investments, Bhavin Shah, deals leader at PwC India, questions the exemption for broad-based funds for 21 countries, which exclude top jurisdictions like Singapore, Mauritius and the UAE, which he claimed jointly constitute over 50 per cent FDI in India. 

“Not including these three countries keeps almost all significant private equity and venture capital funds and start-ups in which they invest, on their toes for angel tax issue. These funds contribute close to 50 per cent of foreign investment in the country today,” he stated.

Punit Shah, partner at tax firm Dhruva Advisors, too, agreed with this perspective. He opined that the benefits of the exemption may not be available to several large private equity funds who invest in India through jurisdictions such as Mauritius, Singapore, the UAE and the Netherlands. 

“Also, the broad-based funds are defined as having more than 50 investors,” he pointed out. “Hence it would be interesting to see whether this benefit is extended to such pooling vehicles making investments in India through specific special purpose vehicles (SPVs) located in non-specified jurisdictions."

Saurrav Sood, practice leader of international tax and transfer pricing at SW India
Saurrav Sood, practice leader of international tax and transfer pricing at SW India

Saurrav Sood, practice leader for international tax and transfer pricing at financial advisory company SW India felt that skipping Singapore, Mauritius and the Netherlands is a deliberate miss even though many investments come from these jurisdictions through SPVs that invest indirectly into Indian start-ups. 

“Further, it also exempts the broad-based pooled investment vehicle which has more than 50 investors. Such a condition of 50 investors is somewhat misaligned with Section 9A provisions which provide safe harbour benefits with 25 investors as a condition there in,” he pointed out. 

There are also murmurs that the start-up exemption for angel tax applies to less than 2 per cent of DPIIT registered start-ups due to a long list of conditions they need to fulfil for seven years period. This could well make the exemption just another paper tiger without any teeth. 

Industry experts observed that the government spends a lot of time making policies after due consultation with the industry. However, the gap between policy intent and implementation needs to be bridged quickly, to catch up on the lost time and to seize the opportunity available to Indian entrepreneurs today.

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