The Indian government has abolished the angel tax, introduced in 2012 to prevent black money through unlisted company shares, to support the startup ecosystem. Finance Minister Nirmala Sitharaman’s announcement in the Union Budget 2024-25 will provide relief to startups seeking to make a significant impact in the competitive Indian economy.
Angel tax
Indian investors were subject to an angel tax on unlisted companies’ shares, if their share price exceeded the fair market value, aiming to reduce unaccounted money in the economy.
Sitharaman highlighted the government’s intent in her Union Budget 2024 speech: “To bolster the Indian startup ecosystem, boost the entrepreneurial spirit, and support innovation, I propose to abolish the so-called angel tax for all classes of investors.”
How did Angel tax impact startups?
The angel tax imposed on startups has imposed a 30% tax on excess investment over the FMV, diverting funds intended for growth and operational expenses. This burden is particularly difficult for young startups in their nascent stages, which rely heavily on external funding.
The determination of FMV is a significant issue, as valuation is a nuanced process influenced by growth prospects and future earnings potential. Tax authorities tend to adopt a conservative approach, leading to discrepancies between investors’ valuations and those recognized by the tax department.
These disputes often result in legal battles, draining resources and attention from startup founders already stretched thin.
How did the tax affect angel investors?
Angel investors, who are crucial for the early-stage funding of startups, were also affected. The tax implications made them more cautious, as their investments were subject to scrutiny and potential taxation.
The government had earlier relaxed angel tax for non-resident investments in a bid to provide relief for startups which sought funds abroad.
1 countries were exempted from the tax. They Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US. But the exemption did not include nations like Singapore and Mauritius where majority of investor firms are located.
This cautiousness translated into reduced investment activity, depriving startups of the much-needed seed capital.
Further, domestic investors in startups approved by an inter-ministerial panel were also exempted if the startups met certain criteria.
How did startups qualify for exemption?
Promoting Investment, Employment & Social Security
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To qualify for exemption, startups had to ensure that their paid-up capital and share premium did not exceed Rs. 10 crore after issuing shares. They also needed to obtain FMV certification from a merchant banker, and the investors were required to have a minimum net worth of Rs. 2 crores with an average income of at least Rs. 50 lakh in the last three financial years.
The Indian government has abolitioned the angel tax, allowing eligible startups to request exemptions directly from the Department of Industrial Policy & Promotion (DIPP), eliminating the need for FMV certification and inter-ministerial board approval.
The Central Board of Direct Taxes (CBDT) was mandated to accept or decline these applications within 45 days. This move is seen as a significant step towards creating a more supportive environment for startups and investors, fostering innovation and making India a global hub for startups.
The startup community has welcomed the move, with many praising it as “long overdue.” The withdrawal of the angel tax is seen as a timely course correction as the government prepares for long-term strategic investment and more risk-capital to promote innovation and R&D. The move has been praised on social media as a “long overdue” move.
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