What was the Angel Tax that got abolished in Union Budget 2024? Why is this good news for startups?

The Indian startup ecosystem has been the focus of business-related conversations all around the globe, and now it has received a significant boost as Finance Minister Nirmala Sitharaman announced something extremely crucial in the Union Budget 2024-25 that will surely bring relief to those startup minds in the subcontinent looking to make it big in this competitive economy.

To bolster the Indian startup ecosystem, the Indian government has abolished the angel tax for all classes of investors. This tax, formally known under Section 56(2)(viib) of the Income Tax Act, 1961, was initially introduced in 2012 following the recommendations of the “White Paper on Black Money”.

The purpose was to prevent the introduction of black money through the issue of shares by unlisted companies. However, its impact on startups and investors has been widely debated and criticised.

What is the Angel tax?

Angel tax was imposed on the capital raised by unlisted companies through the issue of shares to Indian investors if the share price exceeded the fair market value (FMV) of the company.

The excess amount was treated as income and taxed at a rate of 30.9 per cent. This provision was aimed at curbing the flow of unaccounted money into the economy but led to several complications.

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Sitharaman highlighted the government’s intent in her Union Budget 2024 speech: “To bolster the Indian startup ecosystem, boost the entrepreneurial spirit, and support innovation, I propose to abolish the so-called angel tax for all classes of investors.”

The angel tax came into being with the Finance Bill of 2012, driven by the intent to check the introduction of black money into private companies through inflated valuations. It targeted the difference between the actual capital received by the company and what was determined to be the FMV of the issued shares. This difference was treated as the company’s taxable income.

How did Angel tax impact startups?

The imposition of angel tax created a considerable financial burden for startups, many of which were already operating on tight budgets. The need to pay a 30 per cent tax on the excess investment over the FMV meant that crucial funds intended for growth and operational expenses were diverted to tax payments.

This tax burden was particularly challenging for young startups in their nascent stages, which rely heavily on external funding to scale their operations.

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One of the significant issues with the angel tax was the determination of FMV. Valuation is a nuanced process, often influenced by growth prospects and future earnings potential.

However, tax authorities tended to adopt a conservative approach, leading to discrepancies between the valuations agreed upon by investors and those recognised by the tax department. These valuation disputes frequently resulted in legal battles, draining the resources and attention of startup founders who were already stretched thin.

How did the tax affect angel investors?

Angel investors, who are crucial for the early-stage funding of startups, were also affected. The tax implications made them more cautious, as their investments were subject to scrutiny and potential taxation.

The government had earlier relaxed angel tax for non-resident investments in a bid to provide relief for startups which sought funds abroad.

21 countries were exempted from the tax. They Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Israel, Italy, Japan, South Korea, New Zealand, Norway, Russia, Spain, Sweden, the UK and the US. But the exemption did not include nations like Singapore and Mauritius where majority of investor firms are located.

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This cautiousness translated into reduced investment activity, depriving startups of the much-needed seed capital.

Further, domestic investors in startups approved by an inter-ministerial panel were also exempted if the startups met certain criteria.

How did startups qualify for exemption?

To qualify for exemption, startups had to ensure that their paid-up capital and share premium did not exceed Rs. 10 crore after issuing shares. They also needed to obtain FMV certification from a merchant banker, and the investors were required to have a minimum net worth of Rs. 2 crores with an average income of at least Rs. 50 lakh in the last three financial years.

In a bid to simplify the process, a recent government notification allowed eligible startups to request exemptions directly from the Department of Industrial Policy & Promotion (DIPP).

This eliminated the need for FMV certification and inter-ministerial board approval. The Central Board of Direct Taxes (CBDT) was mandated to accept or decline these applications within 45 days.

A new era for startups

The abolition of the angel tax is a landmark decision aimed at creating a more supportive environment for startups and investors. By removing this financial and administrative burden, the government aims to foster innovation and make India a global hub for startups.

The startup community has welcomed this move with many taking to social media to praise the move and calling it “long overdue!”

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“One big takeaway from tax proposals announced in the budget this year is claw back of angel tax levy. Definitely, a positive move that helps reset not only the tax cost matrix for investors in start up as well as for foreign strategic investors, it also puts out a progressive view of tax policy making by the government,” Sumit Singhania, a partner at Deloitte India told Firstpost.

“Since this levy has stinged for more than a decade since it was introduced in 2012, withdrawal of angel tax entirely means a timely course correction as the government rolls out red carpet for long term strategic investment as well more risk-capital to promote innovation and R&D,” he added.

Anmol is a Senior Sub-Editor with Firstpost. He likes to cover stories that intrigue him, generally revolving around international polity, Indian foreign policy, human interest, environment and even the politically-charged election cycles in India. He has far too many disparate interests with a constant itch for travel. Having visited fourteen states in the Indian subcontinent, he is always on the lookout for opportunities to add more to the list. He enjoys watching Football, Tennis and F1 purely as a sports enthusiast. see more