Beware Startup! Your Angel funding may attract Income Tax

Raising the funding may be one of the most difficult step for your startup and if we tell you that you need to pay the income tax on the same, how do you feel? You feel frustrated? Yes everyone will but that is the law of the land and hence, you must understand what is angel tax so that you can save yourself from the clutches of the unfair tax. Let us understand this tax in a little bit detailed manner.

Startup Tax on the first step

A startup company raising capital from angel investor needs to pay tax i.e. Angel tax (start-up tax). The dreaded ‘Angel tax’ introduced by finance act 2012, has changed the lives of many starts up companies who were just in their initial stage of shaping their idea into reality.

‘Angel tax’ simply means, any consideration received on shares by start-up companies which are above the fair market value of shares is to be treated as ‘income’ and taxed under the head of income from another source in tax calculation.      

Example to understand the Angel Tax

Mr. A registered a company to raise their initial funding from an Angel investor. Technically, the company has no value as it is a newly registered company and hence, share valued at only Rs.10. However, the angel investor liked the idea of the founders and willing to invest a sum of money into the business. Suppose he buys 10,000 shares @ Rs.100 per share. Hence, he invested Rs.10 lakh into the same.

Now, as per the market value, the share may be valued at only Rs.10, but the same has been subscribed at Rs.100 per share which means Rs.90 per share extra. Now as per the section of the Income tax act, 1961, the same shall be treated as income in the hands of the company and hence, taxable.

Piece of information - True story

The enormous downfall in valuation of shares of Flipkart has grabbed the attention of the government, the value of shares which was declared in June 2015 at $142.27 dropped to $103.97 in December 2015 and later to $87.9 in March, 2016 resulted in introduction of  angel tax  policy on the startup companies.

Read: Start-ups with slashed valuation may now need to pay tax

How will you calculate angel tax?

The difference between the amount received from investor and the fair market value is treated as income in the hands of the company and later on, tax is levied on the same. Hence, the most important thing is to understand the calculation of fair market value.

Meaning of Fair Market value (FMV)

Rule 11UA (2) stipulates the following two methods for determining the Fair market value for calculation of angel tax( LINK) that are as follows –

• Net Asset Value
• Discounted Free Cash Flow

Hence, the Net asset value is the sum total of the market value of all subscribed shares including cash. The definition of NAV is the value of fund assets less the value of its liabilities per unit. Net Asset Value = (Asset – Liability) / total number of units

Why angel tax is a point of concern?

Angel tax has become a point of concern for the start-up companies because the capital which is actually ought to be determined as liability is considered as income in the hands of the start-up. Not only this, Startup companies are also feeling humiliated by the notices issued by the Income-tax department asking for the reason of raising shares over the fair market value.

The notices are not just issued to the startup companies but also to the angel investor asking for income invested in a start-up company. Hence, this technique has resulted in 40% reduction of angel investment and seed funding relationship. 

It is very clear that if startup won’t get launched, then job guarantee from the sector will also take a bad hit. Due to this, many starts -up took their steps back and dies a premature death.

The mock-up relief of government

In 2016, after looking at the downfall of startup companies, the government proposed a policy which states that those starts- up companies who incorporated before 01.april.2016 with less than 10 crores of angel funding are not charged under angel tax and that startup which recognised by the DIPP (Department Industrial Promotion Policy) will be spared from the coercive measure taken by the government officials.

Decide a way – supporting or stopping

In the year of 2018, the government budget didn’t come up with any sort of relief on angel tax swapping the hopes of small startup companies.

According to Business standard, many startups companies have moved to foreign countries like Singapore and the U.K where taxes are milder.

On one hand, the government is initiating schemes like ‘Make in India’ and ‘Startup India’ to promote startup in our country while on the other hand proposing stringent laws on the startup by introducing tax like angel tax.

Conclusion

The startup tax is the biggest torture for the start-up companies and for the Indian economy too, and silence in the 2018 budget is the biggest disappointment so far.

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