Understanding the Concept of Angel Tax & Its Impact on Startups

What is a start-up and where India stands in the growth of start-ups?

Startups are the young ventures that is just beginning to develop. Startups are usually small and initially financed and operated by a handful of founders. These organizations are generally driven by the latest technology and innovation and have rapid growth prospects. Today India is the 3rd largest hub for entrepreneurs from around the world harboring approx. 26,000 start-ups right now. Govt. has encouraged startups by implementing programs like make in India and Startup India but the introduction of Angel tax has threatened to undo all hard work by Govt. Speaker: CA Shivi Agarwal

What is Angel tax and understanding the levy of such tax?

Angel tax was introduced in 2012 union budget by then finance minister Mr. Pranab Mukherjee. Angel tax is a Term used for Income tax levied on amount recd. Exceeding the fair market value of the share of a company Three conditions are to be satisfied to invoke the provisions of angel tax 1. Shares to be issued by closely held companies  Not applicable in case of listed and widely held companies 2. Investors shall be resident in India Not applicable in case of non-resident investors 3. Amount received shall exceed the face value as well as the fair market value of the share of the company Fair market value shall be calculated as per the provisions as prescribed under the rule 11UA(2) as on the date of issue of such share. There are two methods are prescribed under the rule so as to determine the FMV of the share. First: – FMV shall be calculated by dividing the net worth of the company by the total paid up share capital and multiplied by the paid up value of such equity shares as issued by the company. Second: – FMV can be calculated by a merchant banker following the discounted cash flow method. Income arising from the differential between the issue price and the fair market value is taxed in the hands of the company except for two cases which are exempted from levy of such tax. Such income is taxed under head Income from other sources and taxable at the normal rate as applicable in case of such company.

Exemptions from such levy:

Angel tax has proved to create hardships for a lot of small start-ups and addressing the concerns raised by the entrepreneurs, the DPIIT has issued a line of notifications over the period.

As per the latest notification issued by the department, there are two cases falling under which the assessee can claim exemption from angel tax.

1. Venture capital undertaking receives funds from a venture capital fund or venture capital company.

2. Any other specified class of companies as notified by the central Govt. Three conditions are to be satisfied.

a) T.O. shall not exceed Rs. 100 Cr. In any of the 10 financial year in which it is claiming to be a startup;

b) Co. shall be engaged in developing or innovating idea or scalable project generating employment

c) Paid up share capital including premium shall not exceed Rs. 25 Cr.

The exemption is available with respect to all the shares issued by the co. post incorporation except for those with respect to which addition has already been made.

Compliance to claim exemption:

1. Form 2 is to be filed  2. It is a self-declaration form 3. Submitted to DPIIT(department of production industry and internal trade) 4. Then DPIIT forwards it to the CBDT.

Conclusion: –  Angel tax is levied in case a closely held company receives amount from its resident investors exceeding the fair market value as well as the face value of the share. However, if the issue price does not exceed the fair market value but exceeds the face value of the share, no levy of angel tax is attracted on the company, but the investor will be liable to pay tax on the differential amount between the face value of the share and issue price under section 56(2)(x). Such income shall be assessed under the head ‘Income from other sources’ in the hands of the investor.