Savior or silent strangler of startups? Is the business angel tax about to end?

The provision originally provided that if an unlisted company, such as a start-up, received a capital investment from a resident in excess of the par value of its shares, this additional amount would be considered income for the start-up. Therefore, it would be subject to income tax under the category “Income from other sources” for that tax year.

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Following a recent amendment, the government has proposed to extend this provision to foreign investors. This means that any funding received by a start-up from a foreign investor would also be considered taxable income.

Startups and capital flows: a strained relationship

The angel tax has been a thorn in the side of the Indian startup community. Industry experts say the tax, which is particularly impactful during the crucial early-stage phases when many startups rely heavily on foreign funds, can severely restrict capital flows, especially during times of financial crisis.

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Many experts believe that the Angel tax can have a significant impact on access to funds for startups facing financial difficulties and can also act as a barrier to innovation and ease of doing business.

Exemptions and the current context

While startups registered with DPIIT are exempt from the Angel tax, the reality is that only about 1,34,260 startups are registered, leaving a vast majority of them subject to the tax. The Central Board of Direct Taxes (CBDT) has tried to address this issue by issuing a circular exempting specific investors like sovereign wealth funds and pension funds from 21 countries from the Angel tax on non-resident investments in unlisted Indian startups.

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However, facing strong opposition from the industry and amid reports highlighting a decline in funding for start-ups, the finance ministry has decided to exempt investors from 21 countries, including major economies like the US, UK and France, from the application of Angel Tax on their investments in unlisted Indian start-ups.

DPIIT pressure and industry response

DPIIT’s proposal to dismantle the Angel Tax follows extensive consultations with industry associations and the startup ecosystem.

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The Confederation of Indian Industry (CII) also echoed this sentiment in its budget recommendations, saying that removing the tax “will greatly promote capital formation.” This call for repeal has intensified amid the ongoing financial crisis, with investments in startups falling to a five-year low in 2023.

Sanjiv Puri, Chairman, CII, said in the budget recommendation: “Taxing early-stage investments stifles innovation and entrepreneurship. Removing this disincentive would unleash a flood of capital, propelling the startup ecosystem to new heights.”

The industry argues that the government is ignoring the inherent risk and potential that justify startup valuations. The 2023 Finance Act has exacerbated concerns by extending the tax to foreign investors from April 2024, further confusing the financing avenues for startups.

Experts also believe that the removal of the Angel Tax will accelerate the trend of ‘reverse flipping’, where Indian startups relocate their base to India, and foster a more innovative environment in the world’s third-largest startup economy.

Beyond the business angel tax: a broader economic vision

Besides removing the Angel tax, the DPIIT has recommended phasing out reverse customs duty and reducing high customs duties on inputs in the electronics sector and other industries. These recommendations are part of a comprehensive strategy to strengthen India’s industrial competitiveness.

Singh acknowledged: “I agree that input taxes should be reduced gradually. Ultimately, it will be the finance ministry and the ministry of electronics and IT (MeitY) that will decide on this issue.”

Visa standards and FDI liberalization

The government is also considering simplifying visa norms for companies operating in the 14 sectors covered under the Production Linked Incentive (PLI) scheme, thereby facilitating the movement of investors and skilled professionals. Further liberalisation of foreign direct investment (FDI) is also on the table to attract more international capital into the country. “This will cover all companies investing in any of the 14 sectors, irrespective of their participation in the PLI scheme,” Singh said.