Clipped from: https://www.thehindubusinessline.com/opinion/editorial/angel-tax-is-draconian-and-unfair-on-start-ups/article66676445.ece
This tax is a relic from an era where the start-up scene was not vibrant
There seems to be good reason for India’s start-up ecosystem to protest the Centre’s decision to bring non-residents into the ambit of its angel tax provisions. Introduced as an anti-abuse measure in 2012, angel tax rules require unlisted companies to cough up income tax at 30.6 per cent whenever they receive a capital infusion at a premium to the fair value of their shares. This levy, applicable only to domestic investments till date will be applied on non-resident investments too from April 1.
As this could sweep investments from foreign PE/VC funds, venture capitalists and individual NRIs into the tax net, there is concern that fund-raising will be hit prompting domestic start-ups to domicile overseas. It seems unkind to bring in these provisions at a time when a global funding winter has shrunk PE/VC inflows into India by 29 per cent in 2022. Capital raised from non-resident investors is in any case subject to FEMA rules, where money can only be received via banking channels with full KYC.
Even without going into the issue of whether foreign investors ought to be in its ambit, the logic for levying angel tax is tenuous. Income tax, by definition, is levied on the profits made by an enterprise from carrying on a business activity. Imposing it on capital raised is illogical. Listed companies raise capital all the time from private placements and promoter infusions without attracting any levy, so it seems unfair to impose it on nascent ventures which require higher risk-taking by investors. To arrive at the tax liability, unlisted firms are required to calculate the ‘fair market value’ of their shares using textbook methods such as book value and discounted cash flow, which is quite impractical for early-stage ventures. It is perhaps recognising the validity of such arguments that this government relaxed the applicability of angel tax to some ventures in 2019. DPIIT-registered start-ups were exempted from this tax, provided they raised funds from SEBI-registered category 1 and category 2 AIFs (Alternative Investment Funds).
One understands the original intent of the angel tax provisions, which was to discourage laundering of unaccounted money via unlisted firms disguised as capital investments. But then this tax is also the relic of an era when the start-up ecosystem was not so vibrant and PE/VC investments were not such a significant driver of inbound FDI (foreign direct investments). Today, it is hard to ignore the visible value being created for the economy by bona fide start-ups through innovation, value-added and employment. Over the past decade, there has been a quantum jump in the resources, data and technology available to the taxman to trace the money trail on suspect transactions. Therefore, the time is right for the Centre to discard angel tax and look for other means such as registration of angel investors and disclosure of beneficial ownership of PE/VC/angel funds to plug the abuse of this route.