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Obtaining funding for a startup is extremely difficult. It is said that startups receive money only from friends, fools, and family. However, there is another class of investors which provide money to these organizations. They invest in companies which are at very early stages of their product development. They belong to the same ecosystem as venture capitalists do. They have been nicknamed as “angel investors”.
Across the world, angel investors are viewed as being angels. This means they are viewed positively and governments offer various tax breaks to them for investing in early-stage companies. In the United States, the profits made from investing in one early-stage startup can be set off by reinvesting the money in another early stage startup.
However, in India, this is not the case. Here, angel investments are viewed with suspicion! This is the reason why there are no special tax breaks for angel investors. In fact, the tax policy is creating hurdles for such investments. As per the latest tax laws, startups will now have to shell out 30% of the funding that they receive from angel investors as tax. The amount will be added to the head “income from other sources” and be taxed at the maximum rate. Obviously, this hasn’t gone down well with the startup ecosystem. Startups and investors have started an online petition to pressurize the government to abolish this tax. In this article, we will learn more about India’s infamous angel tax.
India has a big “black money” problem. India has a very low rate of tax compliance. This is because a large number of people evade paying income taxes. Only about2% of its population pay any form of income tax.
The tax department is therefore worried that angel investments are nothing but a form of money laundering. They believe that a lot of startup firms have assets which are off the books of the company. Investors are aware of these assets and hence they provide very attractive valuations to these startup companies. Startup companies have defended themselves saying that receiving attractive valuations is not a crime! Startups do not believe that they are generating any black money by evading taxes.
The tax department does not seem to believe this. Hence, they have their specialists who work out the fair value of a startup based on a predetermined formula. If the valuation received exceeds this fair valuation, then it is subject to the highest level of taxation.
The government of India is wary that their policies are damaging the commercial environment in the nation. Hence, they have come up with a policy which certifies innovative startups. If a startup company has this certification, then they are not subject to the draconian angel tax.
There are very stringent parameters to grant this certification. For instance, the turnover of the company must not be more than 25 million rupees, and the age must not be more than five years. Also, the company must be engaged in the production of an innovative product or service. The problem is that some of these parameters are subjective. Also, government officers in India have a reputation for being corrupt. As a result, less than 5% of the startups that apply for this certification are able to receive it.
The entire system has ended up being a mechanism to harass and fleece the owners of startup companies that are trying to make the world a better place and improve India’s economy while attempting to do so.
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