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Start-ups to find relief from the dreaded “Angel Tax”

The covenants of section 56 (2) (viib) of the income tax, better known as the Angel Tax, have been the bone of contention for many start-ups in the recent past.

The provision mandated that any consideration received by companies for issue of equity over and above the “fair value” of such equity would be subject to tax in the hands of the companies at the rate of 30%.

Our partner Mr Gautam Nayak wrote in the Mint on the said issue and we quote :

“A former Union minister from another state was alleged to have received bribes of ₹550 crore from a foreign company for grant of licenses by receipt of huge premium for allotment of shares in his brother’s media company. The law was then amended in 2012 to tax the premium received by a company in excess of the fair market value of the shares. Today, this provision is causing immense grief to innumerable genuine businesses, in particular, start-ups. As if raising capital to fund a fledgling idea is not difficult enough, start-ups now also have to deal with a tax officer, who has no commercial understanding of a business, let alone fund-raising.

In most cases, huge tax demands are raised on start-ups on the ground that the large premium charged by start-ups is not justified, effectively destroying the business. It is not just start-ups that are affected, even large wholly-owned subsidiaries of foreign companies face the same problem. “

Most startups raise capital at huge premiums based on valuations which are based on forward looking projections, which are by default optimistic. Till the time the tax returns reach the assessment stage the officer has the benefit of historical performance to benchmark the projections. Since the projections are almost always better than the actual results the officer then has the liberty to reject the valuation report and subject the premiums received to the angel tax.

This has sought to be remedied now with the press release issued on the 19th of February 2019 where the definition of start-ups has been expanded

Private companies will be considered start-ups if no more than 10 years have elapsed from the date of their incorporation and their turnover has not crossed Rs 100 cr. This is in contrast to the earlier limits of 7 years and 25 crores respectively.

Further the company should be recognized by The Department for Promotion of Industry and Internal Trade (DPIIT) and should not be investing in a number of specified assets.

Per the press release Angel tax will not be applicable to eligible start-ups upto the aggregate limit of Rs 25 cr

This should definitely come as good news for start-ups raising capital. Those companies which have already seen adverse assessments and demand notices can also breathe easy as news reports indicate that the ministry has instructed officers not to pursue such demands for eligible start-ups and let the cases be settled at the appellate stages. That said, the actual notification may hold more clues as to the implementation of the new provisions and it will be worth revisiting this in due course.

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