In recent years, India has witnessed a thriving startup ecosystem, with many young entrepreneurs and innovative ideas surfacing across the country. Startups have become a vital part of India’s economic growth, contributing to job creation, technological advancement and overall development.
However, amidst this growth, an issue called “Angel Tax” has become a major concern for the Indian startup community. In this article, we will delve deeper into the concept of angel tax, its implications on startups, and the government’s efforts to address this issue.
What is the angel tax?
Angel tax refers to the taxation levied on the excess premium that angel investors pay when investing in startups. When startups receive funding from angel investors or high net worth individuals (HNIs), they often issue shares to these investors at a premium above the par value of the shares.
This bonus reflects the potential and growth prospects of the startup. However, under section 56(2)(viib) of the Income Tax Act, 1961, if the premium on such shares is considered excessive, the amount in excess of the fair market value of the shares is considered as “income from other sources” and taxed. according to applicable income tax rates.
What impact does this have on startups?
Imposing an angel tax has a significant impact on startups, especially those in early stages of development with limited revenue.
First, it creates cash flow constraints, as startups rely on funds to fuel their growth and operations. The tax reduces the capital raised, which hampers their expansion plans.
Second, determining the fair market value of a startup, especially in its early stages, is challenging due to lack of financial data, leading to disputes with tax authorities, resulting in prolonged assessments and unnecessary charges.
Third, the angel tax generates uncertainty and apprehension among angel investors and HNIs, discouraging them from investing in startups, thereby affecting the availability of funds for budding entrepreneurs.
Fourth, Indian startups face a competitive disadvantage compared to their global counterparts as foreign startups do not face a similar tax burden, which affects the Indian startup ecosystem.
Finally, high tax obligations divert startup founders’ attention from innovation and business growth to tax compliance, paperwork, and legal complexities, potentially stifling innovation and hindering overall business development. startup ecosystem.
Angel tax is a contentious issue for Indian startups, affecting their growth, investment opportunities and overall trust in the ecosystem. However, by striking a balance between taxation and support, India can unlock the full potential of its entrepreneurial community and establish itself as a global hub for innovation and startup success.
Government-backed startups in 2022