Angel Tax: New Tax Exemption Rule To End Startup Funding Crunch

Days after the tax department proposed to exempt SEBI-registered FPIs, pension funds and SWFs from the purview of angel tax, the government has notified 21 countries from where non-resident investment in unlisted Indian startups will not attract angel tax.

Seen as breather for startups struggling with funding shortage, the Angel Tax will not be imposed on foreign investment made in unlisted Indian startup firms from 21 countries including the US, UK and France.

However, this list does not include investments coming from countries like Singapore, Mauritius and UAE though highest FDI in India comes from these countries. The government stated in the FY 2023-24 budget that investments in all unlisted companies except for startup companies recognized by the Department of Industry Promotion and Internal Trade (DPIIT) an angel tax will be levied. Since then, the startup and venture capital industry was seeking tax exemption for investment coming from certain countries.

The Central Direct Tax Board (CBDT) issued a notification on Wednesday stating that investors of certain categories would not fall within the scope of the Angel Tax provision. These categories include first class foreign portfolio investors registered with SEBI ( SEBI), endowment funds, pension funds and investments with participation from residents of 21 countriesm. This notification has become effective from April 1, 2023. Countries included in the tax exemption include — Canada, Austria, Czech Republic, Belgium, Denmark, Finland, Israel, Italy, Iceland, Japan, in addition to the US, UK, Australia, Germany and Spain, Korea, Russia, Norway, New Zealand and Sweden.

On May 24, CBDT notified the classes of investors who would not come under the Angel Tax provision. The entities that are excluded are –

• Those registered with SEBI as Category-I FPI, Endowment Funds, Pension Funds and broad-based pooled investment vehicles, which are residents of 21 specified nations as per the notification.
• Banks or regulated entities involved in insurance business, and entities registered with Sebi as Category I foreign portfolio investors (FPIs), endowment fund and pension fund are also in the proposed exempted list.

The so called angel tax which is applicable to startups is essentially a tax levied on the capital raised by a company and was introduced originally in the 2012 Budget. Until the 2023 Budget, the tax was applicable only to domestic individual investors. However, in the 2023 Budget, both foreign investors and NRI investors were also brought under the ambit of the angel tax.

CBDT's Procedure for Pending Angel Tax Assessment Cases to Safeguard Start-ups: Experts

The government's recent decision to give relief to start-ups on assessment of angel tax notices would provide a safeguard to them and promote their growth, according to experts.

Seeking to calm the nerves of start-ups worried about angel tax, the government last week assured that explanation given by them to a tax notice in a limited scrutiny case would be summarily accepted without any questions asked by the taxman.

The Central Board for Direct Taxes' (CBDT) circular with this effect "brings in more safeguard by requiring assessing officers to procure his or her supervisor's consent before starting on any inquiry under the angel tax provision against a start-up company which has not got DPIIT approval," S. Vasudevan, Partner, Lakshmikumaran & Sridharan said.

However, he added that the circular does not specify any minimum rank of the consenting superior officer.

"Also, lack of guidelines as to how the assessing officer or his supervisory officer selects cases for scrutiny may continue to haunt the start-ups," he added.

Amit Maheshwari, Partner, Ashok Maheshwary & Associates LLP said that CBDT's clarification will help start-ups which are facing questioning in their assessments and will also give a clear direction to assessing officers on what to do in such cases.

Naveen Wadhwa, DGM, Taxmann said that the board has also issued a circular to provide relief to start-ups which are undergoing assessment proceedings with respect to angel tax issue.

"The CBDT has directed the assessing officers to accept the contention of start-ups with regards to angel tax issue if start-up is an eligible start-up in view of latest notification of DPIIT," he said.

Nangia Advisors (Andersen Global) Managing Partner Rakesh Nangia said, "Directions of the CBDT that the tax officer will have to summarily accept the contentions of the start-up on valuation of its shares shall provide the relief intended to be provided to the start-ups." PTI RR

Angel Tax Assessment for Startups Gets SIMPLIFIED

Giving a relief to startups, the finance ministry has simplified the angel-tax assessment process under which any action would be taken against such entities only after approval of a supervisory officer.

The Central Board of Direct Taxes (CBDT), in a circular, said that no verification will be done by an assessing officer if a startup has been recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) and the case is selected under limited scrutiny.

In cases where scrutiny assessments of startup entities are pending, the CBDT has decided that the contention of the assessee will be summarily accepted whose cases are under 'limited scrutiny' for those entities recognised by DPIIT.

"In case of startup companies recognised by DPIIT which have filed Form No. 2 and whose cases have been selected under scrutiny to examine multiple issues including the issue of section 56(2)(viib), this issue will not be pursued during the assessment proceedings and inquiry on other issues will be carried out by the Assessing Officer only after obtaining approval of the supervisory authority," an official statement said.

Form 2 deals with the exemption of startups from income tax subject to certain criteria.

If a startup is not recognised by the DPIIT, then too the inquiry would be carried out after the approval of a supervisory officer.

The circular followed the announcement made by Finance Minister Nirmala Sitharaman in Budget.

She proposed a host of incentives, including a special arrangement for resolution of pending assessments of income tax cases, with a view to encouraging startups.

"To resolve the so-called 'angel tax' issue, the startups and their investors who file requisite declarations and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuations of share premiums," she had said.

The issue of establishing the identity of the investor and source of his/her funds will be resolved by putting in place a mechanism of e-verification. PTI DP

Relief for Startups: CBDT Lays out Procedure for Pending Angel Tax Assessment Cases

Seeking to calm the nerves of startups worried over angel tax, the government has assured that explanation given by them to a tax notice in a limited scrutiny case would be summarily accepted without any questions asked by the taxman.

This is part of the procedure being laid out by the Central Board of Direct Taxes (CBDT) to deal with pending angel tax assessments of startups, a move aimed at easing tax compliance for such ventures.

For cases that land in limited scrutiny, "no verification of such issues will be done by the assessing officers during the proceedings...and the contention of such recognised start-up companies the issue will be summarily accepted," the CBDT said in a circular, dated August 7.

Further, in case of limited scrutiny with multiple issues or a complete scrutiny, while an assessing officer may not go into the assessment proceedings with regard to the angel tax issue, the authority would be empowered to verify linked matters with the approval of his/her supervisory officer.

If a startup is not recognised by the DPIIT, then too the inquiry would be carried out after the approval of a supervisory officer.

The income tax department carries out two types of scrutiny procedures -- limited and complete -- which entail submission of additional documents and financial reports.

The move followed after certain startups complained about facing harassment and the taxman breathing down their neck on the angel tax issue.

The circular followed the announcement made by Finance Minister Nirmala Sitharaman in Budget. She proposed a host of incentives, including a special arrangement for resolution of pending assessments of income tax cases, with a view to encouraging startups.

"To resolve the so-called 'angel tax' issue, the startups and their investors who file requisite declarations and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuations of share premiums," she had said.

The issue of establishing the identity of the investor and source of his/her funds will be resolved by putting in place a mechanism of e-verification.

Commenting on the issue, Amit Maheshwari, Partner, Ashok Maheshwary & Associates LLP said that CBDT has come out with a framework to tackle pending tax assessments.

This clarification will help startups which are facing questioning in their assessments and will also give a clear direction to assessing officers on what to do in such cases, he said.

"Contention of startups having DPIIT recognition will be accepted on section 56(2)(viib) of Income tax act and therefore, there would not be any tax adjustment additions on this account," he said.

He added that startups which do not have DPIIT recognition will still have to substantiate the valuations of the assessing officer, if they question them.

"However, as a safeguard this enquiry/verification will be after obtaining prior approval from the supervisory officer," he added.

Nangia Advisors (Andersen Global) Managing Partner Rakesh Nangia said, "Directions of the CBDT that the tax officer will have to summarily accept the contentions of the startup on valuation of its shares shall provide the relief intended to be provided to the startups."

While the recognised startups stand relieved, the ones that are yet to receive a nod from the DPIIT may still have to face the inquiry from tax officers and the procedure to be followed by the tax officers in such cases would be crucial to note, Nangia added.

An angel investor puts funds in a startup when it is setting up its business. Normally, about 300-400 startups receive angel funding in a year. Their investment in a unit ranges between Rs 15 lakh and Rs 4 crore.

After claims being made by several startups that they were receiving tax notices under section 56(2)(viib) of the Income Tax Act, 1961 to pay taxes on angel funds received by them, the DPIIT in consultations with CBDT resolved the issue.

Section 56(2)(viib) of the I-T Act provides that the amount raised by a startup in excess of its fair market value would be deemed as income from other sources and would be taxed at 30 per cent.

Touted as an anti-abuse measure, this section was introduced in 2012. It is dubbed as angel tax due to its impact on investments made by angel investors in startup ventures.

More than 540 startups have received exemption from angel tax so far.

Good News - Angel Investors in Startups Get Income Tax Exemption Up To 100%

Indian tax department yesterday exempted angel investors from income tax on their investments in startups with effect from April 11. The tax concessions are subject to certain conditions laid down by the Department of Industrial Policy and Promotion (DIPP) last month, which said that the share capital and share premium of the startup should not exceed Rs 10 crore after such investments.

Also the angel investor who plans to subscribe the shares in the start-up will have to fulfill prescribed criteria and the start-up will have to procure a report from a merchant banker, specifying the fair market value of the shares in accordance with income tax rules.

The Income Tax Department, on May 24, issued a notification, superseding its June 2016 notification. “…The Central Government, hereby notifies that the provisions of clause (viib) of sub-section (2) of section 56 of the said Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received for issue of shares from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification,” the Central Board of Direct Taxes (CBDT) said in the May 24 notification.

This notification comes into effect retrospectively from April 11, 2018, it said.

The decision to give investors in startups exemption from income tax was aimed at addressing a key issue faced by angel investors who put money during early growth stage, and would also provide level-playing field for all investors. The Commerce and Industry Ministry had on April 11 said that a start-up can seek tax concession under the section 56 of I-T act. The section 56 provides for taxation of funds received by an entity.

The CBDT has also amended Rule 11 UA (2)(b) of I-T Act, thereby making merchant banker valuation compulsory for the purpose of determining fair market value of unquoted equity shares, and omitted the word 'accountant'.

The notification further said that an angel investor with a minimum net worth of Rs 2 crore or an average returned income of over Rs 25 lakh in the preceding three financial years would be eligible for 100 percent tax exemption on investments made into start-ups above fair market value.

The notification is a welcome move in diminishing the fears of start-ups in relation to angel tax and providing the much-needed clarity with respect to non-applicability of angel tax.

Another key takeaway from the notification, is withdrawal of power from chartered accountants to issue valuation reports for purposes of angel tax. This is perhaps designed to bring in more sanctity to issuance of valuation report.

To recall, in this year's union budget, it was announced that time for claiming a tax holiday/exemption by eligible startups has been extended till 1-April 2021.

Startups and investors were expecting that the government will resolve the issue of angel tax in the this year budget of 2018 however the issue was left out completely.

Thereafter, a new clarification by Finance Secretary Hasmukh Adhia stated that genuine cases of startup valuation as assessed by DIPP will be exempt from paying taxes on angel investments received. However, this will also be applicable only for startups founded before 2016.

[Top Image - Blog.iPleaders.in]

Good News - Angel Investors in Startups Get Income Tax Exemption Up To 100%

Indian tax department yesterday exempted angel investors from income tax on their investments in startups with effect from April 11. The tax concessions are subject to certain conditions laid down by the Department of Industrial Policy and Promotion (DIPP) last month, which said that the share capital and share premium of the startup should not exceed Rs 10 crore after such investments.

Also the angel investor who plans to subscribe the shares in the start-up will have to fulfill prescribed criteria and the start-up will have to procure a report from a merchant banker, specifying the fair market value of the shares in accordance with income tax rules.

The Income Tax Department, on May 24, issued a notification, superseding its June 2016 notification. “…The Central Government, hereby notifies that the provisions of clause (viib) of sub-section (2) of section 56 of the said Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the consideration has been received for issue of shares from an investor in accordance with the approval granted by the Inter-Ministerial Board of Certification,” the Central Board of Direct Taxes (CBDT) said in the May 24 notification.

This notification comes into effect retrospectively from April 11, 2018, it said.

The decision to give investors in startups exemption from income tax was aimed at addressing a key issue faced by angel investors who put money during early growth stage, and would also provide level-playing field for all investors. The Commerce and Industry Ministry had on April 11 said that a start-up can seek tax concession under the section 56 of I-T act. The section 56 provides for taxation of funds received by an entity.

The CBDT has also amended Rule 11 UA (2)(b) of I-T Act, thereby making merchant banker valuation compulsory for the purpose of determining fair market value of unquoted equity shares, and omitted the word 'accountant'.

The notification further said that an angel investor with a minimum net worth of Rs 2 crore or an average returned income of over Rs 25 lakh in the preceding three financial years would be eligible for 100 percent tax exemption on investments made into start-ups above fair market value.

The notification is a welcome move in diminishing the fears of start-ups in relation to angel tax and providing the much-needed clarity with respect to non-applicability of angel tax.

Another key takeaway from the notification, is withdrawal of power from chartered accountants to issue valuation reports for purposes of angel tax. This is perhaps designed to bring in more sanctity to issuance of valuation report.

To recall, in this year's union budget, it was announced that time for claiming a tax holiday/exemption by eligible startups has been extended till 1-April 2021.

Startups and investors were expecting that the government will resolve the issue of angel tax in the this year budget of 2018 however the issue was left out completely.

Thereafter, a new clarification by Finance Secretary Hasmukh Adhia stated that genuine cases of startup valuation as assessed by DIPP will be exempt from paying taxes on angel investments received. However, this will also be applicable only for startups founded before 2016.

[Top Image - Blog.iPleaders.in]