Clipped from: https://www.business-standard.com/opinion/editorial/let-start-ups-live-123042001281_1.html
Govt must review angel tax
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The start-up universe is facing challenges because of the funding crunch. The rapid increase in policy interest rates by large central banks, notably the US Federal Reserve, to combat inflation has raised the cost of money. The era of near-free money owing to excessively accommodative monetary policy in the developed world, especially after the pandemic, which pushed up activity in the start-up world significantly, is over. According to one estimate, compared to last year, funding for Indian start-ups declined by about 75 per cent in the first three months of 2023. But the funding winter is not the only problem for Indian start-ups. They can also land in trouble for commanding a premium in the funding market.
As reported by this newspaper on Wednesday, the Income-Tax Department has sent notices to start-ups for raising capital at an “excessive premium” from domestic investors between the assessment years 2018-19 and 2020-21. Under Section 56(2)(viib) of the Income Tax Act, 1961, if the premium received by an unlisted company against the issue of shares is above fair market value, it is liable to be taxed — also popularly known as the angel tax. Thus, the premium higher than the defined methods of fair valuation can be treated as income from other sources and taxed. This tax was introduced in 2012 as a measure to prevent routing unaccounted money through share premium in unlisted companies. It is possible that some individuals and companies may have used this route to channel unaccounted money, but the idea of imposing a tax on all companies is problematic at multiple levels.
Since notices have been sent to start-ups, it is important to note that new-age technology companies are not valued by investors through the same standard textbook methods. Whether the new ways of valuing are appropriate or not is a different debate and it’s for the investors to decide. There is no way that a government or any other entity can arrive at a correct fair value. Financial assets worth billions of dollars are traded every day across the world because investors differ on fair value. In fact, start-ups have witnessed value erosion because of funding conditions. As the flow improves, valuations would change again. It is thus best for the government to stay away from making such judgements, and treating share premium as income makes no sense. It will only make fundraising more difficult for new-age Indian firms, which are necessary not only for driving innovation and job creation, but also for creating value for society at large.
It is odd that the present government, which justifiably takes pride in developing a vibrant start-up ecosystem in the country, has not only continued with a tax provision that was not properly thought through but has made it worse. The Finance Bill, 2023, extended the tax provision, which was limited to domestic entities, to foreign investors as well. Although start-ups recognised by the Department for Promotion of Industry and Internal Trade are exempted, this is not the way to go. The provision is also contradictory to the efforts made by the securities markets regulator, enabling start-ups to raise capital from the public market. The government would thus do well to review the angel tax provision. In any case, it is an acutely inefficient way to tackle unaccounted money.