Govt Promises Remedy in 5 Days to Startups Hounded by ‘Angel Tax’

Startups have complained of harassment by arbitrary ‘Angel tax’ orders by the government.

Minister of Commerce and Industry, Suresh Prabhu, issued a notification on 16 January that seeks to simplify the angel tax exemption procedure. 

(Photo: Kamran Akhter/ The Quint)

Startup and investors will now sit with the government and jointly come up with a set of guidelines to address the ‘angel tax’ problem. This decision was the outcome of a roundtable on Monday, 4 February, where entrepreneurs hounded by ‘angel tax’ got an opportunity to voice their grievances and recommendations to the government.

The Ministry of Commerce and Industry, which convened the meeting, said it will meet with a core group of ecosystem representatives again this week and come up with a set of final guidelines within the next five days.

Some of the primary issues to be addressed in these guidelines will be redefining start-ups and relaxing investor norms. According to members at the meeting The Quint spoke with, government officials acknowledged that ‘it was a shame that startups were being troubled by these taxes.’ 

This meeting had startups, investors including K Ganesh and Padmaja Ruparel, officers from the Central Board of Direct Taxes (CBDT) and officials of the Department for Promotion of Industry and Internal Trade (formerly DIPP). About 35-odd startup founders and investors were present at the meeting on Monday.

Ashish Chaturvedi, a Pune-based entrepreneur who was at the meeting said he had received two tax orders last year for his app, School Diary, a communication tool for schools, students and parents.

“Even the government officials were surprised by the high turnout of startups and I will say they were receptive and heard our concerns with patience. We now hope for a constructive solution to this problem.”

Ashish Chaturvedi, Founder and CEO, uFony,<b> </b>which owns the SchoolDiary app

Why Are Startups Angry ?

A desperate plea by 68 startups in a letter to Prime Minister Narendra Modi on 16 January not only illustrated the distress caused by ‘angel tax’, but also served as an indictment of the government’s various startup initiatives.

“Startups are in distress and many feel victimised mainly due to the subjectivity, cost and arbitrariness involved in the implementation of this anti-evasionary measure which treats every assessee as guilty until proven innocent.”

Excerpt from a letter to the Prime Minister signed by 68 startups

On the evening the same day that the letter was submitted to the PMO, the Ministry of Commerce, headed by Suresh Prabhu, issued a notification announcing changes to section 56 (2) (vii b) of the Income tax Act, which imposes the ‘angel tax’.

However, the relief among startups was tempered by the feeling that provisions of the notification did little to address the real concerns of India’s startup ecosystem.

Taking cognisance of the dissatisfaction among startups with the new exemption rules, the DPIIT, under the aegis of the Commerce Ministry, decided to get all the stakeholders under one roof and work towards an agreeable way forward.  

Did the Core Concerns Get Addressed?

Following are the core concerns that the startups and investors raised during the two-hour meeting at Udyog Bhavan.

Scrap ‘angel tax’ altogether. It is arbitrary and leads to harassment of genuine entrepreneurs.

Govt Response: ‘Angel tax’ as a levy is designed to prevent money laundering in the form of investments in startups. A lot of shell companies park black money this way and hence the tax itself cannot be scrapped but can be redesigned to enable recognised startups to get exemptions.

There should be no condition on who can be an investor.

Govt Response: Similar to the previous response, CBDT officials said that the investors had to be regulated to prevent money launderers from posing as investors and park their money in startups. The officials also provided several examples of such shell companies at the meeting, according to those present. However, DPIIT said that it may move towards a system of accredited investors.

Need to redefine ‘startups’ from 7-year-old to 10-year-old companies

Govt Response: According to entrepreneurs The Quint spoke with, the government is considering raising the threshold for startups from seven to ten and update the list of recognised startups accordingly.

Address the mismatch between how tax assessment officers and investors in evaluating startups.

Govt Response: According to a member present in the meeting, CBDT said that they will look into it and come up with a guideline for assessment. Also, assessment officers will be sensitised towards dealing with genuine startups so that a tax notice or order does not amount to harassment.

Relax the condition that in order to be eligible for the tax exemption, the investor must have an annual income of Rs 50 lakh and a net worth of Rs 2 crore.

Govt response: In principle, DPIIT said that it could lower the threshold to Rs 25 lakh and net worth to Rs 1 crore. More importantly, instead of having to satisfy both criteria, government officials said they would consider accepting either one.

Raise the exemption ceiling of aggregate paid-up share capital of a startup from Rs 10 Crore to over 50 Crore

Govt Response: “We wanted the ceiling for exemption to be raised to Rs 100 crore but I think the government may agree to raise it 50 crore at least,” said Sreejit Moolayil, founder of a health food startup, TrueElements. Chaturvedi, of School Diary app, said that while the word ‘crore’ has a ring to it, in reality 10 crore is not a large sum in the scheme of a growing company.

Those who have already been served with a tax order should also be exempt from ‘angel tax’

Govt Response: DPIIT and CBDT officials made it clear that those who have received an order to pay the tax amount will still not eligible for the exemption. However, those who the only received a notice can be considered for an exemption.

Chaturvedi had been slapped with two such orders and Moolayil one. “Even this morning I got two mails. This can be unnerving for an entrepreneur,” said Chaturvedi.

What Is Angel Tax ?

“Angel Tax”, at the heart of the discontent among start-ups, under Section 56(2) (viib) of the Income Tax (I-T) Act, taxes any investments made by an Indian entity in an unlisted Indian company above fair market value as income. It treats investment as income.

This valuation done arbitrarily and by income tax officials with no domain knowledge lies at the heart of the unrest and distress within the community.

“The tax inspectors only understand the asset-based evaluation of companies, whereas what should be followed is the Discounted Cash Flow (DCF) method, which takes into account future growth prospects. This is much more accurate for asset-light technology start-ups.”

Sreejith Moolayil, Founder TrueElements

The Way Ahead

Sachin Taparia, chairman and CEO of LocalCircles, who has rallied startups and raised issues on their behalf with the government, said that they have made a number of other proposals to ease the problem of ‘angel tax’.

“We proposed that all the 16,000 startups recognised in the DPIIT list shoudl be allowed to submit documents like monthly expenses, employee payroll and PAN details in order to differentiate us from shell companies,” Taparia told The Quint. “What makes us different from shell companies is that they would fail the time test. Once verified as genuine by CBDT, the startups should not be slapped with tax notices,” he added.

A team of five members, including Taparia, Nakul Saxena of software industry think-tank iSpirt, and possibly investor Padmaja Ruparel, will be meeting DIPP and CBDT officials to hash out the details of all the concerns raised, including redefining startups to include companies older companies than seven years. 

The government has assured of a final set of guidelines by the end of the week after detailed consultations with the representatives. “It seems like they are listening to us. We sincerely hope that this translates into concrete results,” Taparia said.