The Indian economy is an eminent illustration of the fact that taxes and tariffs are the main sources of income for governments worldwide. The country has a structured tax system that is decided by the federal and state governments and uses both progressive and proportional taxation depending on income and other criteria. The money the government receives is referred to as income tax which can be used for a variety of projects, including building public infrastructure and amenities.
The major purpose of taxes is to assist the government in achieving its development objectives. It must be noted that India is home to one of the booming start-up ecosystems in the world. As per the industry statistics, approximately 14,000 new start-ups flourished across 555 districts in India during the financial year 2022-2023 (FY22-23). Consequently, the concept of Angel Tax holds great significance in the commercial landscape where the number of potential start-ups is raised to 84,012 in 2022 from 452 in 2016.
To prevent the creation and use of unexplained funds through the purchase of shares of a closely held company at a price over the shares' fair market value, the Angel Tax was first implemented in 2012. In specific scenarios where an unlisted company issues shares at a price above the fair market value, the Angel Tax is applied. It is crucial to comprehend that any premium paid by an investor over the Fair Market Value (FMV) of the shares of an unlisted company will be taxable in the hands of the company. In contemporary times, Angel Tax is levied at a hefty rate of 30.9 per cent on net investments over the fair market value. The start-ups that raise money from domestic investors, venture capitalists etc. abide to pay Angel Tax, thus, the start-up sector does get impacted by Angel Taxes.
Angel Tax on Foreign Investments
Angel tax has been introduced to regularise foreign investments in the country that requires international investors to register with the SEBI (Securities and Exchange Board of India). However, the stated tax may deter investors to venture financially into the nation. The Angel Tax bill may impact the paradigm of foreign investments into domestic start-ups as potential investors may shift their investments to other international avenues because foreign investors expect a favourable rebate on taxes on the capital invested in India. The exemption for foreign funds and non-resident investors was anticipated to be introduced in the Finance Bill of 2023, but they will now be subject to tax on the difference between the capital raised and the fair market value of the securities sold. The proposed Angel Tax increase may further impede foreign investments in the wake of the ongoing drop in international financing.
Impact of Angel Tax on Angel Investors
Angel investors and other seasoned capital investors generally participate in start-ups to seek out higher returns than those typically offered by more conventional mainstream investments. Making the appropriate entry-level investment in early-stage companies and start-ups is essential. Venture capital, which builds on the idea of financing ground-breaking start-ups, draws angel investors not only for the financial rewards but also for the possibility to assist in realising the potential of numerous great organisations. The regulation of the Angel Tax has not been welcomed and embraced by angel investors and investment networks across the country. Since a large portion of the money raised by Indian start-ups come from foreign investors, whose investments are now subject to Angel Tax, this will have significant ramifications for the Indian start-ups ecosystem. The mentioned tax system could force many start-ups to relocate abroad.
Overall Impact on Start-Up Ecosystem
The Angel Tax bill will continue to influence the start-up funding system for years to come. The financing fraternities comprising both, domestic and foreign investors who want to invest a sizable amount of capital have been discouraged by the introduction of the Angel Tax system. The start-up's total paid-up share capital and share premium after the issuance or intended issuance of shares must not exceed Rs 25 crore, nonetheless, to qualify for the exemption. Given the complexity of start-up fundraising, it is frequently unclear how much of any cash infusion a certain investor is exposed to, especially since each round typically involves several investors. The provision of Angel Tax only exempts domestic investors from making tiny start-up investments, which is a major deterrent for capital investors and investment networks that usually invest a big amount of money into the start-up enterprise to generate attractive RoI (Return on Investments).
It can be fairly concluded that domestic entrepreneurs and foreign investors are resentful towards the implementation of the Angel Tax bill. The nation’s start-up financing will be compromised as most capital investors will now prefer to invest in destinations other than India which promise them lucrative profits on the monetary investments made.
Prateek Toshniwal is an angel investor.
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