Angel tax troubles of startups continue to persist – even after Budget 2019 relief

• Finance Minister Nirmala Sitharaman provided a huge relief to startups by doing away with the angel tax in August 2019.
• However, the exemption is limited to startups registered under DPIIT.
• To be recognised under DPIIT, a startup has to have been founded after April, 2016. But there are several startups which were founded before that, which are facing hurdles while registration.

Until August last year, Angel Tax was the demon in the lives of Indian startup founders. Finance Minister Nirmala Sitharaman provided a huge relief to startups by doing away with the angel tax. In August last year, she said that Section 56(2) will not be applicable for startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT).

In reality however, the menace of angel tax continues to persist. Currently, only startups that are registered with the DPIiT can avail of the exemption from angel tax. Startup founders say that this is a limitation.

“There remain many grey areas that should be addressed on a priority basis. At present, only recognized startups are exempt from Angel Tax, but MSMEs operating from rural areas are still bearing the brunt of this unfair taxation system,” said Dr Apoorva Ranjan Sharma, President, and Co-founder of Venture Catalysts.

Currently, there are 27,654 DPIIT registered startups.

Sharma added that some of the new conditions effectively restrict startups from investing in shares and securities. “Given how most startups tend to grow their capital through investments in debt mutual funds, it seems like a classic case of one step forward, two steps back. We expect the government to bring further amendments to the Angel Tax in the Union Budget 2020-21 as this will benefit India’s startup ecosystem to a great extent,” he said.

When startups are in the initial stages, they also raise money from friends and family, which is again subjected to tax. “We may also include tax provisions for friends and families not categorized as angels and have backed non-DPIIT-registered start-ups,” said Nischal Shetty, Founder & CEO,WazirX.

However, as per circular (4 iii), startups not registered on DPIIT can find provisions to be exempted from angel tax. But this too is not being implemented. “Individual assessing officers (AOs) are taxing firms based on their own interpretation of the Act and sending circulars without involvement of supervising officers. The officers are supposed to provide proper reasoning for taxing the premium. However, they just disallow it treating the valuation work as invalid,” said Nikita Rana, co-founder of Spotlight Consulting.

Rana added that the officers are supposed to tax the excess premium received by the startup. However, instead of doing an independent valuation of the startup, the officers tax the entire investment received by the startup.

But it’s not just that. To be recognised under DPIIT, a startup has to have been founded after April, 2016. But there are several startups which were founded before, and who are facing hurdles while registration, claims Aravind S, founder of a tax advisory firm The Filings.in.

“This government was supposed to be pro-startups. And while the ministry and senior leadership maybe in sync, there is a lot to be desired from those who execute orders on the ground. There is arbitrary taxation of angel investment even now at the rate of 30% without the due process being followed. Entire investments are being taxed instead of just the excess premium, and there is no accountability or fairness. We're already seeing a dip in investments and these undue and unfair taxes will only create more cash-flow issues for startups that are already suffering.,” he said.

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