Angel tax exemption – everything you need to know

Introduction:

Angel tax is a topic of significant interest and concern in the startup community. Entrepreneurs and angel investors alike have been grappling with its implications and seeking clarity on the exemptions provided. In this article, we will delve into the details of angel tax and provide you with everything you need to know about angel tax exemption in India.

What is an angel tax?

The angel tax, also known as Section 56(2) of the Income Tax Act, was introduced by the Indian government to curb money laundering through unlisted companies. It aims to tax the excess premium paid by investors when they invest in startups. The intention behind this tax is to prevent the misuse of funds and maintain transparency in the funding ecosystem.

The start-up must provide them with a specific portion of the investment if the overall investment value exceeds the fair market value (FMV), according to the statute that governs angel tax. The additional investment that the start-up receives is viewed as income, which is the foundation of the angel tax. Thus, a start-up is required to pay the angel tax as part of its income tax under Indian Income Tax regulations.

When an unlisted firm issue shares to an investor at a price above their fair market value, angel tax (income tax at a rate of 30.6%) is paid. It used to be restricted to investments made by residents of the country.

Latest Update:

The CBDT vide notified the class or classes of persons to whom the provisions of section 56(2)(viib)of the Income Tax Act, 1961  do not apply as per the notification of 24/05/2023.

In the exercise of the powers conferred by Section 56(2)(viib) sub-clause (ii) the Central Government hereby notifies the following class or classes of persons, for
the purposes of the said clause, namely:-
1. Government and Government related investors such as central banks, sovereign wealth funds, international
or multilateral organizations or agencies including entities controlled by the Government or where direct or
indirect ownership of the Government is 75% or more;
2. Banks or Entities involved in Insurance Business where such entity is subject to applicable regulations in the
country where it is established or incorporated or is a resident;
3. Any of the following entities, which is a resident of any country or specified territory listed in Annexure,
and such entity is subject to applicable regulations in the country where it is established or incorporated or is
a resident:
(a) entities registered with the Securities and Exchange Board of India as Category-I Foreign Portfolio
Investors;
(b) endowment funds associated with a university, hospitals, or charities;
(c) pension funds created or established under the law of the foreign country or specified territory;
(d) Broad Based Pooled Investment Vehicle or fund where the number of investors in such vehicle or fund
is more than fifty and such a fund is not a hedge fund or a fund that employs diverse or complex trading strategies.

Angel Tax Exemption in India

Understanding the complexities surrounding the angel tax, the Indian government has introduced measures to provide exemptions for eligible startups. These exemptions aim to foster the growth of startups and encourage investment in innovative ideas.

Tax Exemption under Section 56 of the Income Tax Act (Angel Tax)

The entity should be a DPIIT-recognized startup. In order to register your new startup click here

After the proposed share issue, the start-up’s total paid-up share capital and share premium, if any, cannot exceed INR 25 crore.

The investor must have a minimum net worth of Rs. 2 crore and a minimum annual income of Rs. 50 lakh for the previous three financial years. An eight-member intermenstrual board should have approved the startup for angel tax exemption.

Income tax rules for angel investors:

The investment must fall between Rs. 25 lakh and Rs. 5 crore.
The funding will be secured for the next three years.
A maximum of 25% of the total investment should be made as an investment.
Investors are unable to invest money in associates.
The start-up or business must generate less than INR 25 crore in revenue.

Eligibility Criteria

To avail themselves of the angel tax exemption, startups must meet certain eligibility criteria defined by the government. The eligibility criteria include factors such as the age of the startup, turnover, and the source of funding. Startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) are eligible to apply for an angel tax exemption.

The investor must have a minimum net worth of Rs. 2 crore and a minimum annual income of Rs. 50 lakh for the previous three fiscal years. An eight-person intermenstrual board was supposed to approve the startup’s request for angel tax exemption.

Starting-ups that qualify for angel tax exemptions must now earn at least INR 25 crore, up from INR 10 crore. Additionally, there is a provision for investors with a net worth of at least Rs. 2 crores or an average annual income of at least Rs. 25 lacks over the previous three fiscal years to receive a 100% tax exemption. For startups that were incorporated after April 1, 2016, there is a 3-year income tax exemption available.

Benefits and Implications

The angel tax exemption provides startups with several benefits. Firstly, it eliminates the tax burden on the excess premium paid by investors, thereby facilitating a smoother flow of funds into the startup ecosystem. It also encourages domestic investment and attracts foreign investors looking to invest in the Indian startup market.

However, there are some implications to consider. While the exemption eases the tax burden on startups, it does not absolve them from complying with documentation and reporting requirements. Startups must diligently maintain records of share premiums, investor details, and other relevant documents to substantiate their eligibility for the exemption.

Steps to Avail of the Angel Tax Exemption

Availing an angel tax exemption involves a series of steps, from the registration process to compliance and reporting.

Registration Process

Startups seeking angel tax exemption must register with the DPIIT through their Startup India portal. The registration process requires providing essential details about the startup, such as incorporation documents, business models, and details of the founders and directors.

Documentation Requirements

To avail themselves of the angel tax exemption, startups must provide appropriate documentation to support their claim. This includes investment agreements, share subscription details, and valuation reports. It is crucial to ensure that all documentation is accurate, complete, and in compliance with regulatory requirements.

Compliance and reporting

Once a startup is granted an angel tax exemption, it is essential to comply with the reporting obligations. Startups must file the requisite forms and reports with the relevant authorities to maintain their exemption status. Regular compliance ensures that startups continue to enjoy the benefits of the exemption and avoid any penalties or complications.

Challenges and Controversies

Misuse and Shell Companies

One of the concerns associated with the angel tax exemption is the potential misuse of funds through shell companies. To address this issue, the government has imposed stringent regulations and scrutiny to ensure the funds are genuinely invested in startups. However, there have been instances where the system has been exploited, leading to increased scrutiny and challenges for genuine startups.

Limitations of the Exemption

While the angel tax exemption has provided relief to startups, it is not without limitations. Startups need to meet the eligibility criteria and maintain meticulous records to substantiate their claim for exemption. Failure to comply with the requirements can lead to disputes and the potential loss of the exemption, impacting the financial health of the startup.

Impact of the Angel Tax Exemption

The introduction of the angel tax exemption has had a positive impact on the startup ecosystem in India.

Promoting the Startup Ecosystem

The exemption has created a conducive environment for startups to raise funds and grow their businesses. It has encouraged angel investors to support promising startups, resulting in increased innovation and job creation.

Encouraging investment and innovation

By removing the tax burden on angel investments, the exemption has incentivized investors to invest in startups. This has led to a higher flow of capital into the startup ecosystem, fostering innovation and technological advancements.

Frequently Asked Questions (FAQs)

Q: How does the angel tax affect startups in India?

A: The angel tax imposes a tax liability on the excess premium received by startups, impacting their financial viability and growth prospects.

Q: What is the process to avail of the angel tax exemption?

A: Startups need to register with the DPIIT and fulfill the eligibility criteria to avail themselves of the angel tax exemption. They must also maintain proper documentation and comply with reporting requirements.

Q: How does the angel tax exemption promote the startup ecosystem?

A: The angel tax exemption encourages investments in startups, fostering innovation, job creation, and economic growth. It creates a favorable environment for startups to raise funds and thrive.

Conclusion

The angel tax exemption has been a significant development in the Indian startup ecosystem. It aims to foster innovation, attract investments, and propel economic growth. While the exemption provides relief to startups, entrepreneurs need to understand the eligibility criteria, comply with reporting obligations, and maintain meticulous records. By creating a conducive environment for startups and investors, the government aims to nurture the startup ecosystem and drive India’s entrepreneurial landscape forward.

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