Amending Angel Tax

Amending Angel Tax

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March 31, 2023

The Finance Bill, 2023, introduced by Finance Minister Nirmala Sitharaman, proposes to modify Section 56(2) VII B pertaining to the Income Tax Act, which deals with the issue of Angel Tax.

Previous provision

• In 2019, the government declared that startups would be exempt from the Angel Tax if certain criteria were met.

• This levy only applies to local expenditures.

Amended provision

• The government has suggested that foreign investors be included in the category of Angel investors within startups.

• When a start-up receives financing from a foreign investor, this is now considered revenue and is Taxed.

What exactly is Angel Tax? - An angel investor is typically a high-net-worth person who finances early-stage start-ups with their own money.

• Angel taxes are levied on funds gathered by companies if they surpass the company's fair market worth.

• It is a 30% tax imposed on startup financing obtained from a foreign investor.

• The Angel Tax, or Section 56(2) VII B of the Income Tax Act, was first implemented in 2012.

• Goal - To deter the transfer of unaccounted money through unlisted companies masquerading as capital investments.

• The tax applies to investments in private business entities and companies.

• Exemptions - The only types of donors whose assets are exempt from the Angel Tax are those listed below.

i. CAT I and II AIFs registered with SEBI (alternate investment fund)

ii. CAT I and II AIFs that are IFSCA-registered (under the IFSCA FME Regulations, 2022)

Note: A Startup is described as an entity based in India that was founded less than ten years ago and has a yearly revenue of less than Rs 100 crore.

What are the issues with the start-up amendment?

1. Financing - The change could have a negative effect on the financing accessible to start-ups, which have already been suffering from a funding cold since 2022.

2. A funding winter - is a prolonged time of decreased capital transfers to companies.

3. Additional Tax Liability - Startups that receive Angel Tax notifications must pay 30% of the investment collected as tax and twice that amount as a penalty for breaking the exemption requirements.

4. Reverse Flipping - With the suggested adjustments, more companies may be forced to turn abroad.