Post Budget 2019: Will Startups Finally Get Relief From Angel Tax?

Budget 2019 Speech addressed the issue head-on and promises relief on three fronts including funding from e-verified investors

The mentioned promises have the potential to rid the Indian startup ecosystem of the spectre of “angel tax”

However, only if executed without any additional conditions or caveats

Mr Speaker, Sir, my tax proposals will aim to stimulate growth, incentivise affordable housing, and encourage startups by releasing entrepreneurial spirits. It will also be geared towards promoting the digital economy. I aim to simplify tax administration and bring greater transparency. — Honourable Finance Minister, July 5th, 2019

The Budget 2019 will go down in history for being the first speech to publicly acknowledge the dreaded angel tax or section 56(2)(viib) of the Income Tax Act, 1961. This section, introduced in 2012 by the then UPA government, sought to tax capital raised by private companies and startups as income based on the difference between the fair market value and the issue price of the securities.

For over seven years, the Indian entrepreneurs and angel investors ecosystem has cried itself hoarse at this discrimination Indian investors face in their own country and the detrimental effect this has had on Indian entrepreneurs and investors. No other country actively discriminated against its own citizens from investing in companies the way India did.

The current government has taken concrete steps in addressing this issue and the recent circular in February 2019 by DPIIT and the CBDT one in March 2019 helped mitigate the spectre of angel tax from the Indian startup ecosystem vocabulary. However, Section 6 of the circular effectively excluded companies who had already received orders, the ones who were in dire need of relief, from the purview of the circular. The angel tax saga for them continued.

But sections 113–116 of the Budget 2019 Speech addressed the issue head-on and promises relief on three fronts:

• Funding from e-verified investors “will not require any kind of scrutiny from the Income Tax Department” — Section 113
• Special Administrative arrangements by the CBDT “for pending assessments and redressal of grievances” — Section 114
• “No inquiry or verification” in “angel tax” cases without the approval of the above Special Administrator — Section 114

This has the potential to rid the Indian startup ecosystem of the spectre of angel tax provided that it is executed without any additional conditions or caveats.

Taxing investments as income goes against the very heart of the premise of “income tax” itself. This section has deterred domestic participation in the Indian startup story, caused entrepreneurs to set up base in foreign jurisdictions when India is their primary market, caused domestic investors to be evicted from rounds for foreign investors and accelerated India’s descent into a digital colony.

In fact, more than half of India’s unicorns (billion-dollar businesses) and soonicorns (soon to be billion-dollar businesses) are domiciled outside India, with angel tax, access to capital and more favourable regulations being a reason for the same. This is in spite of them having India as their primary market and talent base.

But for this promise of freedom from angel tax to hold true, Indian entrepreneurs and angel investors require the following assurances:

• The e-verification should not place artificial barriers to entry or deny any investor, no matter how small, the chance to participate or invest in startups
• That the e-verification will be a simple process and will not be onerous on the investors:

1. This means that information available with the CBDT will not be called for again in different formats
2. The verification is time-bound and will be completed within a reasonable time period, say 7 days from submitting the documents
3. This is done on an investment level and it will be valid for a period of at least 2 years
4. Re-verification should be done within 24 hours

• Pending cases should be closed in a time-barred manner — by December 31st, 2019 and any adjustments of the demand amount against tax refunds to be reversed
• The “Special Administrator”, whose permission is required to open any fresh cases, consists of representatives of the startup ecosystem in addition to tax officers

Starting off one’s entrepreneurial journey is fraught with numerous challenges and anxieties, without angel tax becoming another cross that entrepreneurs have to bear. All Indian entrepreneurs and investors have suffered the misapplication of section 56(2)(viib), an anti-abuse measure to prevent the “circulation and generation of unaccounted funds”, to their capital raises.

In the story of Startup India, this one section has come to represent the disconnect of our regulations from the ground reality and is considered as a black mark against the entire country, who after 72 years of independence, still treated Indian investors as inferior to foreign capital

There are plenty of reasons not to startup or begin the journey of becoming an entrepreneur. Our Finance Minister needs to ensure that the tax is not one of them. If it doesn’t, India and the Tax Department will be a lot poorer for the same.

___________________________________________________________________

This article was first published on July 9, 2019 on Inc42. Read the original article here.