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TMI BlogAbolition of Angel Tax: A kaleidoscopic study of its triumphs and failuresX X X X Extracts X X X X X X X X Extracts X X X X ..... Abolition of Angel Tax: A kaleidoscopic study of its triumphs and failures X X X X Extracts X X X X X X X X Extracts X X X X ..... namic policy frameworks which aimed to support innovation. However, one misstep in policy-the implementation of the Angel Tax-turned this vision to nightmare for the future entrepreneurs and investors. The Angel Tax faced several challenges and criticism from the entrepreneurs and investors alike, it has proved to be a significant barrier to both innovation and investment in the country. Today, with its abolition, the path for India`s startups looks much clearer, offering renewed hope for the future. What is Angel Tax? Angel Tax is referred to as a tax which is levied on startups when they receive equity investments considered above the fair value in the market, known as FMV. Key Provision The provision of Angel Tax is given under Section 56(2)(viib) of the Income-Tax Act, 1961, vide the Finance Act, 2012. It was introduced to curb the problem of money laundering but became a bone of contention for startups' innovations. But this abolishment has given a more supportive environment for startups or whether it has led to unforeseen challenges. This provision was bought to tax any excess premium received by a closely held company upon the issue of shares. These were introduc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as an anti-abuse provision to prevent the generation and circulation of unaccounted money through share premiums received from resident investors in a private limited company in excess of its fair market value ('FMV'). What is FMV OR Fair Market Value? Fair Market Value or FMV refers to the price set for selling or purchasing an asset in the open market. Financial institutions like NBFCs and Government organizations use Fair Market Value while assessing the valuation of collateralized or taxed assets. What makes FMV different from Market Value? The following additional determinants divide the understanding between Fair Market Value and Market Value: Several conditions need to be fulfilled to determine an asset's FMV. Buyers and sellers must have full knowledge of an asset before participating in a transaction. Their decision should not be influenced by time or any other external factors. Each is given a reasonable period for completing the transaction. e.g., Insurance claims, charity, property taxes, stock ownership, etc., are some transactions requiring this value. Who are the Angel Investors? Angel investors are wealthy individuals who financially support start-up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ventures or small businesses in exchange for ownership equity or convertible debt. Typically, angel investors are successful business people, entrepreneurs, or high-net-worth individuals seeking to invest in promising opportunities.(Seedling stage) inception, ideation or beginning stage. They play a crucial role in the early stages of a business, offering not only financial backing but also insights, mentorship, and industry connections. Angel investors contribute more than just capital; they provide strategic guidance, help navigate business challenges, and leverage their networks for the company's benefit. Angel Tax falls under the umbrella of 'Income from other Sources' as the premium which is received by these unlisted companies. Research Question Is the abolition of the Angel Tax in India having a positive impact on startup funding and entrepreneurial activity, or has it created new challenges for investors and policymakers? Objectives of the study This research seeks to achieve the following objectives: * To evaluate the immediate and long-term impact of the Angel Tax by analyzing the response of key stakeholders (startups, angel investors, and policymakers) to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the abolition of the Angel Tax * To compare the startup environment before and after the abolition. * To identify any unintended consequences resulting from the policy change, including potential loopholes or new challenges. Evolution of Angel Tax in India Angel Tax was first introduced in 2012 as an anti- abuse measure to take a toll on money-laundering happening in the name of seed-funding and investments. But the strict policy was seen as a hindrance to the startup culture in India. Therefore, in 2016, to boost emerging start-ups, the government relaxed norms, and announced an exemption to be given to the startups registered with the उद्योग संवर्धन और आंतरिक व्यापार विभाग Department for Promotion of Industry and Internal Trade from such Angel tax. However, the lower prescribed threshold limit of Rs. 25 crore was easily crossed by start-ups. Due to conflicting opinions on valuation, new rules were established in 2017 wherein value shall be adopted based on the higher value cal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... culated as per prescribed Rules, or the value that could be supported to the satisfaction of the Assessing Officer. The situation until April 1, 2023 was angel tax applied to a closely held company when investments were received from domestic investors only. The valuation norm prescribed to value equity shares were adjusted Net Asset Value method, or Discounted Free Cash Flow method and higher of the two valuations can be opted as fair market value. Further, companies could also substantiate the value of the shares before the Income Tax Authorities, based on the value of its assets, including intangible assets (such as goodwill, know-how, patents, licenses, franchise rights, etc). While the exemption from angel tax was provided to Category I and II Alternative Investments Funds & Start-ups registered with DPIIT on meeting certain parameters, a large set of Start-Ups were left out due to non-compliance with the conditions. In 2023, these provisions were also extended to money received by an Indian company from non-resident shareholders. Further, new valuation methodologies were prescribed resulting in numerous complications. Now, Budget 23rd July 2024 abolished the angel tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provisions for all categories of investors. Necessity of Abolishment India's startup ecosystem, the third largest in the world, aims to become a $10 trillion economy by 2030. "The big step taken today will help us attain this goal," says Aparna Thyagrajan, co-founder of Shobitam, an Indian ethnic wear brand, and an angel investor who appeared on Indian Angels, one of the first angel investment shows on JioCinema. Bhavik Vasa, founder and CEO of GetVantage, stated that the abolition of the angel tax will significantly benefit small and medium enterprises (SMEs) beyond startups. This development is expected to attract various forms of capital and financing, including equity and quasi-equity, to the high-growth segment. Manas Pal, co-founder of PedalStart, noted that by eliminating the angel tax, startups can retain more capital for growth and innovation, making Indian startups more attractive to investors and fostering a vibrant entrepreneurial environment. While the startup ecosystem celebrated the abolition of the angel tax, Shubham Jhuria from Aeravti Ventures noted that five years ago, the tax was a significant issue. Angels and non-structured groups struggled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to invest due to discrepancies between Fair Market Value (FMV) and agreed valuations. Though the abolition removes confusion and complexity, it doesn't significantly simplify investments in Indian startups. Combined with the increase in Long Term Capital Gains to 12.5%, this sends mixed signals about investing in the startup sector. All of these statements of these industry leaders are evident enough to show the complexities and dilemma regarding this Angel tax. Pre- Angel Tax Abolition Era Before the abolition of the Angel Tax, startups in India faced some significant challenges. As stated above, this section 56(2)(viib) of the Income Tax Act, 1961 was implemented to prevent money laundering by tax capital raised by startups if the amount exceeded the Fair Market Value (FMV) of the issued shares. While the intention was to curb black money, the Angel Tax became an issue of contention for the startups trying to legitimate funding. It has significantly impacted the startup ecosystem of India into the following three ways: Impact on Startups The lack of clarity and complexity in valuation methods created significant friction between the startups and tax authorities. Many st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... artups reported receiving tax notices, questioning the valuation of their equity and investments. This uncertainty stifled innovation, as entrepreneurs hesitated to raise funds due to fear of excessive taxation. Impact on Investors Angel Investors, who typically invest in early-stage startups, faced difficulties in justifying their valuations to the tax authorities. The fear of tax scrutiny discouraged many budding investors who had a lot of potential to lead decreased in this angel funding. This inturn backfired, and impacted the flow of capital into the startup ecosystem, especially for the startups in their early stages. Policy Regulations Despite several relaxations and exemptions provided by the government, such as the 2016 exemption for the DPIIT-registered startups, the problem persisted. The situation became particularly challenging for the startups that exceeded the thresholds or struggled to justify their FMV-Fair Market Value assessments, leading to a significant outcry from the entrepreneurial community. Bid to attract investments to Indian startups The Minister of Commerce and Industry, Mr. Piyush Goyal also said, The decision will help attract investments in I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndian startups and further promote the growth of budding entrepreneurs. The move would mainly help emerging sectors like deeptech, artificial intelligence, clean energy, among others, which require a large amount of capital at an early stage. Earlier also, the government has made several amendments to make this tax regime more conducive for investors and startups. A change was made under the Finance Act 2023 proposed to include investments from foreign investors or non-residents within the scope of the angel tax with effect from April 2024. Certain exemptions notified by the Central Board of Direct Taxes (CBDT) stated that the provisions do not apply to DPIIT-recognised startups, certain classes of foreign investors, and entities from 21 nations. Further, guidelines regarding valuation methodologies were also notified by the CBDT. However, it was felt that the provisions were hampering the industry at large, the growth of the startup ecosystem, particularly inbound investments, an official said. Joint Secretary, DPIIT Mr. Sanjiv said, "multiple representations were received by the department from stakeholders concerned, highlighting the potential adverse impact of the angel ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x." Before suggesting the removal, the DPIIT officials studied various international regimes and their approaches were analyzed by them, he said. For investors, this move would infuse confidence into India's investor community and is expected to remove a lot of the risk for investors in very early-stage companies, leading to an increase in the number of overall active investors in India, he added. As on date, about 1.44 lakh startups are recognised by the DPIIT. As per the Huran Global Unicorn Index 2024Unicorns in India have dipped due to the slowing down of the startup ecosystem. Currently, India has over 1.17 lakh DPIIT-registered startups in the country. The demand for the abolition of the Angel Tax was also made by the opposition parties and was recommended by the Department of Promotion of Industry and Internal Trade. The removal of the Angel Tax is now sure to ease the worries of the startup ecosystem. Post-Abolition : New scope for opportunities or challenges? Opportunities: The abolition of the Angel Tax in the 2024 Union Budget has been celebrated as a much-needed reform. By removing this hindrance, the government aims to rejuvenate the startup ecosystem and attr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act more investment. However, this transition will not be a smoother one. Increased Investment: The abolition is expected to remove the uncertainties which inturn will increase investor confidence regarding valuations and tax implications. It will increase the inflow of investments by domestic and foreign investors into the Indian startups, particularly in the sectors like Artificial Intelligence, clean energy, and deep tech, which require substantial early-stage funding. Simplified Processes: Startups can now focus on growth and innovation without the fear of tax scrutiny on their valuations. Their regulatory clarity is likely to encourage more and more young entrepreneurs to seek funding, potentially increasing the number of startups receiving angel investments. Positive Sentiment: The abolition is expected to send a strong signal to global investors that India is committed to give a conducive environment for startups. This may help Indian startups compete more effectively on the global stage. Challenges: Implementation Concerns: While the abolition of Angel Tax seems to be a welcome step, there are still challenges present. Startups and investors need clarity on how valuati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons are carried on and will be treated according to the new tax regime and how the government plans to handle cases that were previously subjected to the tax. New Regulatory Issues: While this abolition is there, another problem emerges which is regulation. The increase in Long-term Capital Gains tax to 12.5% could offset some of the benefits of the abolition, sending mixed signals to investors about the overall tax environment for startups. Global Competitiveness: While India has removed the Angel Tax, other countries continue to allure the investors and startups more by offering them tax incentives. India should understand the competition and act accordingly by broadening the tax and regulatory framework. Case Studies: The Impact of Angel Tax Abolition on startups To understand the practical implications of this abolition, we will know about the startups that were previously impacted by the Angel Tax and have benefited since its removal. Although there has not been enough time since this declaration, we can learn about it from some case studies. T.V. MohanDas Pai, who is a Padma Shri Awardee and the former CFO (INFOSYS) in his interview with moneycontrol said, "It's so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sad that the state government and central government spend more than 8 lakh crores a year on subsidies but the startup sector which gives employment for young people gets peanuts. 1000 cr is not going to shift anything for a large 4 trillion dollar economy today they should have made 50,000 crores or 5 years but Angel Tax is abolished but what they should do now is to withdraw all cases on the startups in the last five years on the angel tax and stop the harassment." Another interview by Moneycontrol with Mr. Aman Dhall, who is an angel investor at Basic home loan & SUGAMYA FINANCE said, "It is a great move by the government. I think it will address all the concerns of the investors of all different kinds especially if you look at the funding in the last year or so there has been a little decline. There have been other reasons for it apart from the angel tax but for sure the evolution of Angel Tax will be a great boost for the startup ecosystem which is growing and can really be a driver for India to shine." Global Tax Policies and examples to learn To draw lessons for India, it is necessary to look at how other countries have structured their tax policies to promote startup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... growth and investment. This part of the paper will compare regimes in countries like the United States, the United Kingdom, and Singapore. United States In the U.S., there is a more startup innovation-conducive environment, with policies like Qualified Stock Business Stock (QSBS) exemptions that allow investors to exclude gains from taxable income if they invest in qualifying startups. This encourages early-stage investments and fosters a thriving startup ecosystem. Becoming a stockholder in a start-up can deliver outsized growth opportunities. However, rapid share price increases could also trigger outsized tax liabilities. Internal Revenue Code Section 1202, also known as the Qualified Small Business Stock (QSBS) exclusion, provides a way to reduce those federal income tax liabilities by offering a partial or full exclusion on the gains realized from certain small business stock. In fact, in some cases, shareholders may be able to shield 100% of their capital gains from tax. United Kingdom The U.K. offers several tax incentives for startups and investors, including the Seed Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS). This scheme gives tax reliefs to inv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... estors who invest in qualifying startups, significantly reducing the tax burden and promoting entrepreneurship. Singapore Singapore`s tax policies are highly favorable for startups, with exemptions on capital gains and a low corporate tax rate. The country also offers grants and incentives to startups in key sectors, attracting global investors and investors. India can learn from these global practices by continuing to refine its tax policies to create a more competitive environment for startups. The abolition of the Angel Tax is a step in the right direction, but further reforms are necessary to align India's tax regime with global practices. Conclusion The decision of the Indian government to abolish the Angel Tax marks a significant milestone in the evolution of the Indian startup ecosystem. While the move has been celebrated widely, it is important to note that there are major challenges to investment patterns and entrepreneurial activity. This research aims to provide a comprehensive analysis of the triumphs and tribulations associated with the valuable insights for policymakers, investors, and startups. By continuing to refine its regulatory framework, India proves t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o have a lot of potential to be a global hub for innovation and entrepreneurship. Based on the above research, the following recommendations are proposed to enhance the regulatory framework for startup funding in India: Clarity on Valuation Rules: Provide clear guidelines on how valuations will be treated in the post-Angel Tax era to avoid confusion among startups and investors. Support for Early-Stage Startups: Introduce additional tax incentives or grants in emerging sectors like AI and clean energy to encourage innovation. International Collaboration: Learn from the global best practices in startup taxation and continue to refine India's policies to foster a more dynamic and supportive startup ecosystem. References. * Angel tax abolished to boost India's startup ecosystem and Innovation; experts hail decision (2024) Business Today. Available at: https://www.businesstoday.in/union-budget/story/angel-tax-abolished-to-boost-indias-startup-ecosystem-and-innovation-experts-hail-decision-438502-2024-07-23?onetap=true (Accessed: 23 August 2024). * Kapoor, P. (2024) Abolishment of angel tax - a welcome move, KPMG. Available at: https://kpmg.com/in/en/blogs/home/posts/2024/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 08/abolishment-of-angel-tax-a-welcome-move.html (Accessed: 22 August 2024). * Angel tax abolished to boost India's startup ecosystem and Innovation; experts hail decision (2024) Business Today. Available at: https://www.businesstoday.in/union-budget/story/angel-tax-abolished-to-boost-indias-startup-ecosystem-and-innovation-experts-hail-decision-438502-2024-07-23?onetap=true (Accessed: 23 August 2024). * (No date a) JFTLVaH Laö Mhö ,YÖ&33004@99 VLK/kj.k hkkx II--[K.M 3-- ... Available at: https://www.startupindia.gov.in/content/dam/invest-india/Templates/public/198117.pdf (Accessed: 24 August 2024). * Section 56 of Income-Tax Act, 1961 (ita)-income from other sources (no date) cleartax. Available at: https://cleartax.in/s/section-56-of-the-income-tax-act (Accessed: 24 August 2024). * https://www.thehindu.com/business/Industry/angel-tax-was-on-investments-such-inflows-should-not-be-taxed-dpiit-secretary-rajesh-kumar-singh/article68440497.ece * Angel Tax Abolishment in budget 2024 a 'watershed moment' for startup ecosystem, say investors (2024) Moneycontrol. Available at: https://www.moneycontrol.com/news/business/startup/angel-tax-abolishment-in-budget-02 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4-a-watershed-moment-for-startup-ecosystem-say-investors-12775945.html (Accessed: 25 August 2024).
* https://www.hurun.net/en-US/Rank/HsRankDetails?pagetype=unicorn
* (Inside the Qualified Small Business Stock (QSBS) exclusion) accessed 25 August 2024 X X X X Extracts X X X X X X X X Extracts X X X X
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