India’s startup ecosystem, a vibrant and rapidly growing sector, has recently come under scrutiny due to proposed changes in the Finance Bill 2023. Referred to as the ‘Angel Tax,’ Section 56(2) VII B of the Income Tax Act has been a subject of concern for startups, primarily due to its implications on equity investments.
Unravelling the ‘Angel Tax’
Commonly known as the ‘angel tax’, Section 56(2) VII B was introduced in 2012. This section outlines that for unlisted businesses such as startups, equity investments from residents issued at a price above their face value are treated as income. For instance, if a startup share’s fair market value of Rs 10 per unit and it is sold to an investor for Rs 20 during a funding round, the difference of Rs 10 would be taxable as income at 30 per cent. The objective of this clause was to prevent the creation and use of unaccounted money through the overvaluation of shares.
The new amendment in the Finance Bill 2023 proposes to broaden the scope of the angel tax to include foreign investors. Before this, startups and investors enjoyed an exemption from angel tax, bringing relief to many in the ecosystem. However, the proposed changes aim to remove this exemption for foreign funds and non-resident investors. They will now have to pay a tax on the difference between the capital raised and the fair value of securities sold.
Implications for the Startup Ecosystem
A recent PwC India report indicated a significant 33 per cent drop in startup funding to $24 billion in 2022 compared to the previous year. A large part of this funding came from foreign investors, like Tiger Global, which has invested in over a third of the startups that have reached unicorn status. The new amendment can potentially lead to a slowdown in investments or even cause startups to flip outside India due to increased tax liability.
The proposed changes have raised concerns and initiated heated debates within the startup and investor communities. There is widespread confusion and hope that the government will not impede foreign direct investments. Many fear that the return of the angel tax may cause further strain on already stressed startups, potentially impacting their ability to grow and prosper.
Impact of Proposed Changes
The proposed amendment primarily impacts offshore funds. These include some of the largest VC investors in India, such as Tiger Global, Sequoia Capital, SoftBank, Accel, and early-stage investors like Y Combinator, AngelList, and others. Given the substantial contribution of these funds to Indian startups, the new angel tax could severely disrupt the inflow of foreign direct investments.
The finance ministry’s decision on whether to clarify exceptions under this potentially more ominous avatar of ‘Angel Tax’ is eagerly awaited by the investor class. Startups may face an increased disclosure burden, and the compliance landscape for them might become more complex.
In an interesting turn of events, the government proposed to exclude certain foreign investors including sovereign wealth funds and pension funds from the purview of the “angel tax”. This move provides much-needed relief to startups and shows that the government is responsive to the concerns raised by the startup ecosystem.
Conclusion
The potential implications of the proposed changes in the Finance Bill 2023 are far-reaching. However, with careful consideration and constructive dialogue between the government, the startup ecosystem, and investors, it may be possible to strike a balance between preventing money laundering and ensuring that startups continue to have access to the funding they need.
The startup community and investors are advocating for clarity and predictability in tax laws, which is crucial for maintaining investor confidence and fostering startup growth. One suggestion is to simplify tax procedures and reduce regulatory overhead, making India a more attractive destination for startup investments.
While the proposed changes to the ‘angel tax’ regulations have created uncertainty in the startup community, they also present an opportunity for the government to address this issue in a way that continues to promote startup growth in India. Balancing the need for financial transparency and accountability with the need to foster a vibrant startup ecosystem will be key moving forward. With the right steps, the Indian startup ecosystem can continue its trajectory of growth and innovation.
(The author is the founder of UnlistedKart)
Comments
0 comment