Indian Government Rolled out New Amendments under Section 56 (2) (viib)

The Indian economy is the third largest hub for startup companies to thrive. The growth process of a startup is not easy as it has to surmount various obstacles. Capital is the primary help that the startup seeks in its initial journey, which it receives from angel investors. The angel investors are not like other investors; they shore up the startup in the beginning without being concerned about profits.

What are Angel Investors? 

Essentially, an angel investor is a well-off person who offers capital to a startup, commonly in exchange for ownership in shares or convertible debts. At the beginning of the entrepreneurial journey, a startup receives monetary help from angel investors when no other investor shows his/her confidence in the startup.

However, the investment, which has been received by the startup from angel investors, is taxable as under Angel Tax. The angel tax is introduced and regulated by the Indian government.    

What is Angel Tax?

The angel tax was originally introduced in 2012 by then-Finance Minister, Pranab Mukherjee, to draw check on money laundering. The angel tax is liable on the income of unlisted companies which raise capital through the issue of shares, wherein the issue rate of shares is higher than the actual share market value. The difference between the rate of issued shares and share market value is considered as income and thus, levied by the government.

How Angel Tax is Affecting Startups

After the implementation of Angel tax, a perturbed issue came out as the Indian startups began demanding that the government should use discounted cash flow (DCF) method rather than net asset value (NAV) to calculate angel tax. As startups grapple in the initial years, it becomes difficult to surmount the financial numbers as projected in the documents. Thus, startups demanded of using the DCF method, as reported by the Indian daily news, The Economic Times.  

Following this, startups were burdened to levy angel tax as high as 30 per cent. Besides the Indian startups, Angel investors were sent notices by the income tax department. According to a survey conducted by social media platform, LocalCircles, more than 2,000 startups that had received funding from investors—angel financiers, private equity and venture capital funds—have received angel tax notices. That’s about 73% of the 2,883 respondents.

Government Reframes Regulations for Startups and Angel Investors

To reduce troubles of the startup as well as angel investors, the Indian government along with DPIIT (Department for Promotion of Industry and Internal Trade) and CBDT (Central Board of Direct Taxes) has revised amendments under Section 56 and have made changes in a start-up's definition.

As per the revised amendments, a company will be called a startup for ten years from the date of its incorporation. Further, the turnover rate of a startup company is incremented from INR 25 crore to INR 100 crore.

Aside from changing the definition for startups, the government bodies (DPIIT and CBDT) have loosened up conditions to claim an exemption under Section 56 (viib). As per the new guidelines, the aggregate amount of shares premium and share capital for startup companies the following issue or planned issue of shares has been incremented to INR 25 crore.

According to new regulations, angel investments will exclude non-resident, venture capital fund and listed companies (whose shares are massively traded and have net worth beyond INR 100 crore). Similar to the abovementioned guidelines, there are many more amendments framed by the government.

After rolling out new amendments, it is significant to view how the new angel tax leverages startups as well as angel investors.