In recent years, India has witnessed a thriving startup ecosystem, with numerous young entrepreneurs and innovative ideas surfacing across the country. Startups have become an essential part of India's economic growth, contributing to job creation, technological advancements, and overall development.
However, amidst this growth, an issue called "Angel Tax" has emerged as a significant concern for the Indian startup community. In this article, we will delve into the concept of angel tax, its implications on startups, and the efforts made by the government to address the issue.
What is angel tax?
Angel tax refers to the taxation levied on the excess premium that angel investors pay while investing in startups. When startups receive funding from angel investors or high-net-worth individuals (HNIs), they often issue shares to these investors at a premium, which is higher than the face value of the shares.
This premium reflects the potential and growth prospects of the startup. However, under Section 56(2)(viib) of the Income Tax Act, 1961, if the premium on these shares is considered excessive, the amount exceeding the fair market value of the shares is deemed as "income from other sources" and taxed as per the applicable income tax rates.
How does it impact startups?
The imposition of angel tax has a significant impact on startups, particularly those in the early stages of development with limited revenues.
Firstly, it creates cash flow constraints as startups depend on funds to fuel their growth and operations. The tax reduces the capital raised, hindering their expansion plans.
Secondly, determining the fair market value of a startup, especially in its early stage, is challenging due to limited financial data, leading to disputes with tax authorities, resulting in prolonged assessments and unnecessary burdens.
Thirdly, angel tax generates uncertainty and apprehension among angel investors and HNIs, discouraging them from investing in startups, thus affecting the availability of funds for budding entrepreneurs.
Fourthly, Indian startups face a competitive disadvantage compared to their global counterparts as foreign startups do not have a similar tax burden, affecting India's startup ecosystem.
Finally, the high tax liabilities divert the focus of startup founders from innovation and business growth to tax compliance, paperwork, and legal complexities, potentially stifling innovation and hindering the overall development of the startup ecosystem.
Angel tax has been a contentious issue for Indian startups, impacting their growth, investment opportunities, and overall confidence in the ecosystem. However, by striking a balance between taxation and support, India can unleash the full potential of its entrepreneurial community and establish itself as a global hub for innovation and startup success.