The Union Budget 2019 was announced on 5th July, 2019. Start-ups took centre stage as the Finance Minister announced a host of relief measures for them. Even in the interim budget presented in February, 2019, start-ups figured prominently as part of the vision for the development of Indian economy over the next decade.  There was emphasis on “Make in India” with particular reference to start-ups, MSMEs, defence manufacturing, automobiles and electronics.

An insight into some of the major goodies announced by the Finance minister for the start-ups in the budget:

1. It is proposed to start television programme(s) with national television channels exclusively for start-ups. The objective being to highlight and discuss issues affecting the start-ups that have a bearing on the growth, funding and tax planning. The channel is proposed to be executed by start-ups themselves.
2. Tax provisions / proposals have been introduced with the intention / objective of stimulating the entrepreneurial spirits. By incentivising start-ups, it is also intended to promote digital economy. A simplified tax administration, especially for start-ups will ensure greater transparency.
3. In order to resolve the “angel tax” issue, start-ups and their investors who file relevant declarations will not be subjected to any kind of scrutiny in respect of valuations of share premium.
4. It is proposed to put in place an e-verification mechanism to establish the identity of investor as well as the source of funds. This way, while there is sufficient transparency in the process as well as statutory compliance, this will further not require any scrutiny by the Income tax department.
5. The Central Board of Director taxes (CBDT) has been directed to put in place special administrative arrangement to address issues of pending assessments as well as redress start-up grievances. To achieve this, it has been decided that no inquiry / investigation / verification can be initiated by an assessing officer unless such officer obtains prior approval of their supervisory officer.
6. It is proposed to extend relief of valuation of shares to Category II Alternative investment funds as well. Presently start-ups are not required to justify fair market valuation of their shares issued to Category I Alternative Investment Funds (AIF). By relaxing the statutory compliance requirement for Category II AIFs as well, valuation of shares will end up being beyond the scope of scrutiny of the Income tax department. The objective of such relaxation being ease of doing business – from the point of view of raising funds as well as from the compliance perspective.
7. The period of exemption of capital gains arising from sale of residential house for investment in start-up has been extended by another 2 years - upto 31st March, 2021.
8. The period of set off and carry forward of losses in case of eligible start-ups has been relaxed. It is proposed to enable them carry forward losses on satisfaction of any one of the two conditions – (i) continuing to hold 51% shareholding / voting power OR (ii) continuity of 100% of original shareholders.
9. The condition of holding minimum of 50% of share capital or voting rights in the start-ups is proposed to be relaxed to 25%.
10. It is proposed to relax the restriction of transferring new asset (computer / computer software) to 3 years (from 5 years)
11. Profit linked deduction was introduced for start-ups. This has been done with a view to promote employment opportunities and growth in start-ups.

One of the biggest concerns’ because of which the start-up fraternity was up in arms was the imposition of the angel tax. The start-up community has made several representations with the IT department and the government to alleviate the burden of the tax.

The union budget 2019 has put that to rest by announcing the exemption of paying angel tax subject to filing requisite declarations. Eligible start-ups only have to file a duly signed self-declaration by with DPIIT for availing tax exemption.

Why “Angel” tax is no “angel” after all?

When start-ups (unlisted companies) raise capital /funds through issue of shares, it mostly does so at premium. Tax is imposed on the differential amount between fair market value of the company and the amount of premium. This is because under section 56(ii) of the Income Tax Act, the excess amount is treated as “income from other sources”. The rate of was an exorbitant 30.9%. While this applied to not only already existing private companies, this applied to new start-ups as well. Invariably start-ups took early stage funding from residents in India. Such tax is called “angel tax” as it largely affects angel investors investing in start-ups. Such angel tax is applicable to the capital raised from Indian investors only. Funds sourced from non-residents and venture capital funds were exempt from this tax.

Challenges of “angel” tax

One of the biggest challenge was valuation of start-ups. Start-ups which are nascent are almost always valued basis their intangible assets such as goodwill and estimated future projections. This makes the valuations subjective. The credibility of fair value arrived through such valuation is always questionable.  Higher valuation would benefit promoters as it means parting with lesser equity. However, this could also lead to discreet money laundering. Therefore the angel tax was introduced as an ‘anti-abuse’ provision.

As such start-ups have very few sources of funding. Normally they have to go to angel investors to raise funds. The exorbitant tax rate of 30.9% often deterred angel investors from investing. Such rate of tax, the investible surplus becomes lesser thus affecting growth prospects.

Start-up: the future of economic development

India is considered the 3rd largest start-up ecosystem after USA and China. World over investors and venture capitalists are optimistic about the potential and growth of the Indian start-ups. The Department of Industrial policy & promotion (DIPP now called “DPIIT”) has recognized 19,840 start-ups and has granted angel tax exemption to almost 600 start-ups. With around 32 unicorn start-ups based in India, and the trade faceoff between USA and China, this seems to be the right time to accelerate the Indian start-up ecosystem. They will have create further jobs and generate revenues. As the President of India stated in the Parliament about India reaching 1,00,000 start-ups by the year 2024, the abolition of angel tax is the first step towards the same. Start-up and stop not until the goal is achieved.