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No relief to start-ups from angel tax provisions in Finance Bill amendments

March 24, 2023 

The only two classes of investors whose investments are exempt from angel tax are SEBI-registered CAT I and II AIFs as well as IFSCA-registered CAT I and II AIFs

Startups have failed to get any significant respite from the proposed change in the angel tax regime, expected to hamper foreign funding for young companies, announced in the Budget last month.

As per the list of amendments to the Finance Bill, which was passed in the Lok Sabha on March 24, the proposed changes will come into effect for Assessment Year 2024-25 or Financial Year 2023-2024. "There was confusion about whether this goes live from April 1, 2024 or April 1, 2023. But the memorandum to the Finance Bill 2023 clearly states that it applies from Assessment Year 2024-25, which is Financial Year 2023-24. April 1, 2024 in the Finance Act refers to the Assessment year, not financial year," said Siddarth Pai, managing partner at 3One4 Capital.

However, a background note shared by the Finance Ministry said that all concerns raised by stakeholders in implementation of this proposal would be addressed. "The draft rules related to valuation shall be shared with the stakeholders for their inputs in the next month itself, viz April. Exclusions, as already provided to domestic Venture Capital Funds etc, shall also be considered for similar overseas entities," the note added. If the funding winter was not enough of a problem, the government threw another curveball at startups with its Union Budget as an exemption for money raised from foreign investors under the angel tax regime was done away with in the Finance Bill, 2023. However, the exemption for investments made by SEBI-registered alternative investment funds still continues.

According to experts, the new tax provision could severely dent startup investments in the country by foreign investors such as SoftBank, Tiger Global, Alpha Wave and Sequoia. "The startup ecosystem still holds hope for exemptions to international institutional investors like VC funds, Sovereign Wealth Funds, etc. The Central Government is empowered to do so via notification. The hope is that the notification comes before April 1, 2023 so that ongoing funding rounds aren't disclocated," said Pai.

"With the passing of the Finance Bill, 2023 - the applicability of angel tax on foreign investors has been cemented. The only 2 classes of Investors whose investments are exempt from Angel Tax are SEBI-registered CAT I and II AIFs as well as IFSCA-registered CAT I and II AIFs (under the IFSCA FME Regulations, 2022)," he added. The angel tax regime was originally started in 2012 as an anti-abuse measure to prevent money laundering. It mandated that a start-up's fundraise could be taxed whenever the funding round happened at a valuation more than the fair value of shares - as determined by a merchant banker.

As the premium on valuation of shares is one of the most contentious things in the angel tax issue, industry bodies had sought a revision of the relevant angel tax rules of determining valuation. As opposed to the current requirement of a discounted cash flow valuation, a change to "internationally accepted valuation methodologies" had been asked for. In order to make it harder for bad actors to abuse the concessions made for startup investments, the industry bodies had proactively suggested more stringent rules. These included mandating that securities of startups have to be held in dematerialised form and not registering any transfer of shares for cash, but only via cheques, demand drafts, banking channels or other such electronic means. Over the years, startups and investors have raised an alarm about being troubled by the taxmen due to the provision even in the case of genuine investments. Startups have said that they received tax notices on angel investment raised 3-4 years prior. In some cases, the sum that the startups must cough up as tax and late payment fee even exceeded the original funding amount.

[The Hindu Business Line]

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