What is Angel Tax? Key Features and Abolition of Angel Tax

Finance Minister Nirmala Sitharman scrapped the angel tax in a bid to strengthen the startup ecosystem and to support innovation in the country. Know all about Angel tax in this article.

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Finance Minister Nirmala Sitharman scrapped the angel tax in a bid to strengthen the startup ecosystem and to support innovation in the country. Know all about Angel tax in this article.

What is Angel Tax?

The angel tax, formally known as Section 56(2)(viib) of the Income Tax Act (ITA), was introduced in 2012. Its primary aim was to curb money laundering and the flow of unaccounted funds. Under this provision, any investment made by unlisted companies through the issuance of shares was scrutinized. If the investment was made at a premium above the fair market value of the shares, the excess amount was classified as “income from other sources” and subjected to taxation.

Origins of Angel Tax

The concept of angel tax was first introduced in the 2012 Union Budget by then Finance Minister Pranab Mukherjee. It was conceived as an anti-abuse measure to curb money laundering through investments in startups and to identify bogus firms. The tax targeted investments made by unlisted companies through the issuance of shares at a premium, which exceeded the fair market value of the company.

Key Features of Angel Tax

Applicability: The tax applied to investments exceeding the fair market value of a startup.
Tax Rate: The excess amount was taxed at approximately 31%.
Investors Affected: Initially applied to domestic investors, the tax was later extended to include foreign investors.

Who are Angel Investors?

Angel investors are high-net-worth individuals (HNIs) who invest their personal income in business startups or small and medium-scale companies. They differ from other investors due to their willingness to invest in early-stage startups, often taking on higher risks in exchange for potential high returns.

Challenges and Criticisms of Angel Tax

Valuation Disputes

One of the primary issues with the angel tax was the challenge of accurately determining the fair market value of startups. Valuation methods like the discounted cash flow (DCF) often resulted in subjective assessments, leading to disputes between startups and tax authorities.

Retrospective Application

Startups often received tax notices for investments made several years prior, with the tax liability and penalties sometimes exceeding the original investment amount. This retrospective application created significant financial and operational hurdles for startups.

Regulatory Burden

The complex regulatory environment and the scrutiny of funding sources and investor credibility added to the challenges faced by startups. Many entrepreneurs argued that the tax was excessively unfriendly and hampered their ability to raise capital efficiently.

Impact on Fundraising

A survey by LocalCircles in 2019 revealed that over 73% of startups that had raised capital between Rs 50 lakh to Rs 2 crore received angel tax notices. This widespread impact highlighted the tax’s detrimental effect on the startup ecosystem.

Exemptions and Reforms

In an effort to address these concerns, the government introduced exemptions for startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT). However, only those certified by the Inter-Ministerial Board (IMB) were eligible, and less than 1% of the 84,000 DPIIT-registered startups had this certification.

Abolition of Angel Tax

The decision to abolish the angel tax in the Union Budget 2024 was a significant step towards fostering a more supportive environment for startups. The removal of this tax is expected to provide several benefits:

Enhanced Innovation: Startups can now focus more on innovation and development without the looming threat of excessive taxation.
Increased Investment: The abolition is likely to attract more domestic and international investments, providing startups with the necessary capital to grow.
Regulatory Clarity: The removal of the tax simplifies the regulatory landscape, making it easier for startups to operate and raise funds.
Global Competitiveness: With a more favorable investment climate, Indian startups can better compete on the global stage.

Conclusion

The abolition of the angel tax marks a pivotal moment for the Indian startup ecosystem. By removing a significant regulatory and financial hurdle, the government has demonstrated its commitment to supporting entrepreneurship and innovation. This move is expected to pave the way for increased investment, accelerated growth, and enhanced global competitiveness for Indian startups, solidifying India’s position as a leading hub for innovation.

Angel Tax FAQs

Who will pay angel tax?

It targeted investments made by unlisted companies through the issuance of shares. This tax was imposed on any premium paid by investors above the fair market value of the shares, classifying it as "income from other sources" and subjecting it to taxation.

Is angel tax removed?

Giving a big relief to startups, finance minister Nirmala Sitharaman on Tuesday announced the removal of angel tax for all classes of investors.

What is angel tax with example?

For example, if a company's fair value is Rs 1 crore and it raises Rs 1.5 crore from angel investors, the excess amount of Rs 50 lakh is subject to this tax.

Who introduced angel tax?

Introduced in 2012, Angel Tax was enacted under the Finance Act of that year. At the time, Pranab Mukherjee, late President of India, was the Finance Minister of the country.

How much is angel tax in India?

Eliminating the tax, which imposed up to 30% on investments, is expected to boost funding opportunities, rejuvenate investor confidence, and attract more investors.