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Why proposed change in Angel Tax has rattled Indian start-ups? - IAS Academy in Coimbatore

Why proposed change in Angel Tax has rattled Indian start-ups?

Context: According to a proposal made in the Finance Bill, 2023, foreign/angel investors may be required to pay the “angel tax,” which was previously only supposed to be paid for investments raised by resident Indian investors.

Angel Investors

●        Angel investors primarily provide capital for startups at early stages in exchange or convertible debt or equity ownership.

●        Angel investors often choose to get an accredited investor status (as per the SEBI AIF Regulations – an individual with a net worth of ₹7.5 crores/ whose annual income is ₹2 crores).

●        However, an accredited investor is not necessarily an angel investor.

●        To be an angel investor, they require having an interest in providing capital for startups.

Pros:

●        Less risk than taking out a small business loan

●        Angel investors typically have experience in investing

●        Mentorship, guidance and valuable insights for the startup

●        Research shows that angel investors’ supported startups are more likely to have substantial growth and give a higher rate of return.

Cons:

●        Loss of equity, loss of control in the business

●        Anticipate a high rate of return on their investment

 What exactly is the proposed change?

The Finance Bill 2023, has proposed to amend Section 56(2) VII B of the Income Tax Act.

According to the clause (introduced in 2012 and commonly known as the ‘angel tax’), equity investments from residents for the issuance of shares at a price above their face value are treated as income for unlisted businesses like start-ups.

For instance, if a start-up share has a fair market value of Rs 10 per unit and is sold to an investor for Rs 20 during a subsequent funding round, the difference of Rs 10 would be taxable as income (at 30%).

By subscribing to shares of a closely held company at a price over the shares’ fair market value, it aims to prevent the creation and use of unaccounted money.

However, with the latest amendment, the government has proposed to also include foreign investors in the ambit.

 Why are start-ups concerned?

According to a PwC India report, funding for India’s start-ups dropped by 33% to $24 billion in 2022 as compared to the previous year.

Foreign investors are a key source of funding for start-ups and have played a big role in increasing the valuation.

For instance, Tiger Global has invested in over a third of the start-ups that have turned unicorns (valuation of at least $1 billion).

The proposed amendment will accelerate flipping overseas, as foreign investors may not want to deal with additional tax liability.