"Startup Scene Shaken Up: The Return of Angel Tax Brings New Challenges in 2023"

Last week's Budget 2023 had many amendments that are still brewing with tense conversations. One such change is the taxes on startup capital raised. While in 2019 startups excluded from the angel tax exhaled a sigh of relief, the dreaded levy on capital receipts is now reinstated.  

What is an angel tax and why was it imposed in the first place? 

In simple terms angel tax refers to the tax levied on the amount of funding obtained by businesses from angel investors. It was mainly introduced in India to avoid tax evasion via the guise of angel investments.

The whole agenda of bringing this act was to prevent money laundering, the conversion of black money into white by round-tripping, etc.

What is round tripping and how does it come into play with the angel tax? 

Round-tripping refers to the act of routing funds via an overseas system in order to make it appear as a legitimate transaction when it is actually just a domestic transaction. 
Let's take a simple example, imagine company A from India gets investment from a group of domestic investors. The funds invested by the investors are routed through a foreign company they own, making it look like a foreign investment. 
On paper, the Indian company declares this as FDI (Foreign Direct Investment) and receives government incentives for doing so. But in fact, the entire transaction was merely a domestic one and the funds just traveled through a foreign entity. 

In order to tackle all these shady transactions, the tax was introduced in 2012. 

So whenever domestic investors were seen paying a premium price above the face value or the market value, then they have to shell out a tax on the excess money received. This was the government's way of expanding its horizon for taxation but, in this process it was evident that it was hurting a lot of genuine entities.

We all know that startups struggle to find investors and once they get funded, they have to keep a huge portion of their initial capital to pay for the tax. Because of these struggles the government introduced exceptions, which were: 

1. the tax provision was applied to only domestic investors 
2. FDI - were not taxed 
3. tax was exempted if startups hadn't completed 10 years of operations and turnover is less than 100cr. 
4. the startup's total paid-up share capital and share premium after issuing or proposing to issue shares must not exceed INR 25 Cr. as the primary requirement.
5. additional exemption for alternative investment funds (AIFs) established with SEBI and cash received from foreign investors

But in last week's budget, the government dropped a bomb by removing the angel tax exemptions on FDI. Now you might think well it isn't that big of a change, it was applicable only for domestic investment now it's imposed on FDI.

The after-effects:
While taxing a foreign investment there are 2 things that come into play, the Foreign exchange management act and the Income tax act, and depending upon the rules you might see a lot of variations in the valuation. Investors could shy away from investing in startups when tax implications are huge. 

It seems like the government is trying to draw a line in the sand. Hopefully in the next few weeks will get to see how severe this impact is gonna be.

Other voices : 

Siddarth Pai, founding partner of 3one4 Capital: “This will have far-reaching implications for the Indian startup ecosystem as a majority of the funds are raised from overseas investors, whose investments will now be subject to Angel Tax. This move may push many startups to redomicile overseas.”

Anand Lunia, partner at India Quotient, said, “The inclusion of offshore VC funds as non-residents for the purpose of angel tax comes as a surprise because surely the government doesn’t want to impact FDI flow. This will also create issues with multiple valuation methods for FEMA and tax purposes. The government needs to clarify this quickly.”

for more detailed info : 
https://inc42.com/features/angel-tax-indian-startups-faqs-explainer/