Budget 2019: Has The Angel Tax Ghost Been Buried For Good?

The Budget’s announcements on startups and the Angel Tax need to be implemented on-ground immediately.
A costumed reveler stands for a photograph during a Halloween party. (Photographer: Mariana Greif Etchebehere/Bloomberg)
A costumed reveler stands for a photograph during a Halloween party. (Photographer: Mariana Greif Etchebehere/Bloomberg)

The Angel Tax was introduced in Budget of 2012 by then Finance Minister Pranab Mukherjee to prevent money laundering through shell companies. It was termed so as it primarily impacted angel investments in startups.

Angel investors are affluent individuals who seek to invest at early stages of startups. These kinds of investments are risky and, usually, do not represent more than 10 percent of the angel investor's portfolio.

The Angel Tax basically refers to Section 56(2)(viib) of the Income Tax Act which brought into the tax net the capital received by an unlisted company through the issue of shares to a resident in excess of its fair market value. However, it does not apply to startups receiving funds from registered venture capital investors and Alternative Investment Funds-I category.

As a consequence, a large number of startups had received income tax notices for scrutiny assessments and to pay this angel tax. Moreover, angel investors have also received tax notices asking them to furnish details on their source of income, their bank account statements, and other financial data. This has, in turn, made further fundraising a challenge for startups.

In January 2019, the government liberalised the conditions for startups and investors to safeguard them from the clutches of angel tax. The regulation provided for a simpler mechanism for startups to claim exemption from angel tax, even for past investments. Startups, whose aggregate amount of paid-up share capital and share premium does not exceed Rs 10 crore after the proposed issue of shares were granted an exemption.

The 2019 Interim Budget was expected to address the problem of angel tax on startups. It did not do so, and as a consequence, expectations from this budget of a big relief were very high.

This Budget has made another attempt to address the concerns of startups, especially on the Angel Tax.

  • Certain startups exempt from Angel Tax

To encourage startups and give them the much-desired relief from the sting of the Angel Tax, the Finance Minister declared that “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”.

  • Genuineness of the investor

An e-verification mechanism has been proposed in the budget for securing requisite filings from startups and investors for identifying the investors of the start-ups and their source of funding.

  • Relief for legacy cases

The Finance Minister, while giving relief to legacy cases, said that special administrative arrangements would be made by the Central Board of Direct Taxes for pending assessments of startups and redressal of their grievances. It was further mentioned that “it will be ensured that no inquiry or verification in such cases can be carried out by the assessing officer without obtaining approval of his supervisory officer”.

  • Additional category of Investor not subject to Angel Tax

The government has now exempted Category-II AIFs from the purview of the Angel Tax. Presently, startups are not required to justify the fair market value of their shares issued to registered venture capital investors and Category-I AIFs.

  • Capital gains exemption conditions for investments in startups relaxed

Presently, under Section 54GB(5) of the Income Tax Act, long term capital gains on the sale of residential property are exempt if the sale proceeds are invested in an eligible startup, provided such transfer took place prior to March 31, 2019. Giving further relaxation, Budget 2019 proposes to extend the deadline for investment by two years, i.e. up to March 31, 2021.

Further, the requirement of holding a minimum 50 percent share capital or voting rights of such startups has been relaxed to 25 percent.

Additionally, it was provided that the startup shall use the amount invested to purchase assets and should not transfer an asset purchased within five years. However, the budget has also proposed to relax the condition restricting the transfer of a new asset like a computer or computer software from the current five years to three years.

  • Carry forward of losses

Under the existing provision, an eligible startup company can claim a carry forward and set-off of losses, provided that all the shareholders of the company in the year in which the loss is incurred continue to be the shareholders of the company in the year of set-off. Such loss should have been incurred within seven years from the date of incorporation.

To provide further relief it has been proposed that the set-off of the losses shall be available on satisfying either of the above condition rather than both the conditions.

In other words, it now provides the flexibility of satisfying either the continuation of 51 percent of the beneficial ownership requirement or continuation of 100 percent of the legal ownership requirement (between the last day of the year in which the loss was incurred and the last day of the year in which the carried forward loss is sought to be set off) for setting off carried forward losses.

Is This Enough?

Budget 2019 is paving way for a brighter future for India’s startup ecosystem with easing the Angel Tax, ensuring more entrepreneurs jump into the startup bandwagon. The question would remain – is this enough and can we see these announcements being implemented on-ground immediately?

Maulik Doshi and Manpreet Bagga are Partners at SKP Group.

The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its Editorial team.

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