Angel tax is a term used to describe the income tax levied on the capital raised by unlisted companies through the issue of shares. Specifically, it targets situations where the share price at which shares are issued exceeds the fair market value of the company. The excess amount is considered income and taxed accordingly under Section 56(2)(viib) of the Income Tax Act, 1961.
Why was Angel Tax Introduced?
The primary purpose behind introducing the tax was to address concerns about money laundering and the potential for the flow of unaccounted funds into the system. Prior to the implementation of angel tax, some companies were suspected of issuing shares at inflated prices to disguise the transfer of black money. The government aimed to curb this practice by taxing the difference between the fair market value and the issue price of the shares. Additionally, the angel tax was intended to ensure transparency in startup valuations. In the early stages, startups often lack a clear track record or established financials, making it difficult to determine their fair market value objectively. The angel tax provisions were introduced to discourage companies from artificially inflating their valuations to attract investments.
Impact on Startups
The imposition of this tax proved to be a significant challenge for startups in India. It created a hostile environment for early-stage investments, discouraging angel investors and venture capitalists from funding new ventures. The uncertainty and potential tax liability associated with angel tax hindered the growth of the startup ecosystem.
Exemptions and Relief Measures
Recognizing the negative impact of angel tax, the government introduced certain exemptions and relief measures to alleviate the burden on startups. These measures included:
- Exemption for startups meeting specific criteria: Eligible startups could apply for exemption from angel tax if they met certain conditions regarding paid-up capital, investor qualifications, and other parameters.
- Relaxation of valuation norms: The government introduced some relaxations in determining the fair market value of startups, providing some relief to startups and investors.
In a significant move to boost the startup ecosystem, the Indian government announced the abolition of this tax in the Union Budget 2024. This decision was widely welcomed by the startup community as it removes a major hurdle to fundraising and encourages early-stage investments.
