Dear PM Modi, Do Away With the “Tax Terrorism” of the “Angel Tax”

Raghav Bahl explains why the “Angel Tax” is a double whammy on the Indian investors.

Photo: The Quint/Kamran Akther

Video Editor: Mohd Ibrahim
Video Producer: Anubhav Mishra
Cameraperson: Abhishek Ranjan

It’s an astonishing repudiation of Stand-up India, Start-up India, Digital India, Make In India and God knows how many more of Prime Minister Narendra Modi’s pet schemes. Just over the last month, 2,000 Indian start-ups have received notices from the Ministry of Corporate Affairs (MCA) asking them to “justify the premium” at which they have raised equity funds or else face harsh penalties and taxes.

"Angel Tax” Returns to Haunt Investors

This has reopened and sprinkled fresh salt on old wounds. It’s actually a second whammy for the same “crime”. Because two years ago, the Income Tax Department had issued similar notices, slapped taxes, and begun prosecution under the dreaded “angel tax” provisions.

And this time, the MCA has expanded the probe beyond angel investors, to include private equity and venture capital investments made during the later and more mature phases of a company’s growth.

What is “Angel Tax”?

Frankly, this so-called “angel tax” is an outrageous levy which places the power to “value” start-ups in the hands of clueless inspectors. When even the most successful global professionals – private equity and venture capital experts – get valuations right less than once in ten times.

Valuation of a Company Based on Individuals

Valuations, like beauty, lie in the eyes of the beholder! Let me give you a hypothetical, but realistic, example. Imagine if five investors, each wanting to buy a 50 percent stake in Flipkart, had valued the company at $1 billion, $2 billion, $3 billion $10 billion or $15 billion in 2012, when Flipkart was in its very early stages, and losing a lot of money.

Now each person’s different valuation call would have depended on his or her:

• Relative risk appetite
• Return on equity benchmarks
• Time horizon of the invested capital
• Understanding of the e-commerce business
• Bullishness on India’s economy
• Role in the company, that is, whether he or she was a pure financial investor or a strategic one who would have liked to stay with the company over decades etc, etc, etc!

Now, each person or institution would have given different weights to these individual factors and arrived at any number of different valuations. And note this: Each would have been right because Flipkart was eventually sold, six years later for $20 billion in 2018.

But hold on; under India’s “angel tax” provisions, even the taxman has to estimate or validate the valuation. And since the taxman is not an expert here, and since Flipkart was losing hundreds of millions of dollars every year in 2012, perhaps the taxman would have given a rather poor and miserly valuation, say $0.5 billion based on some outdated concept of “Net Asset Value” or some such pure current accounting number without understanding and allowing for the future growth of the company.

Now hold your breath; if the taxman had indeed made a valuation estimate of $0.5 billion, Flipkart and its investors would have been forced to pay the following taxes:

• $200 million for the $1 billion valuation guy
• $600 million for the $2 billion investors
• $1 billion for the $3 billion chap
• $3.8 billion for the $10 billion man
• $5.8 billion for the $15 billion aggressive lady.

And these taxes would have been slapped even before a penny of cash gains were realised by the incoming investor!

Why Would an Investor Pay Cash Taxes Before Making Profits?

Do you seriously think any of our hypothetical investors would have put money under such a tax regime where they were being coerced to pay cash taxes on unrealised/uncertain “profits”?

So dear Prime Minister Modi, I’ve just run out of words to describe how destructive – frankly, this is a textbook example of what is often called “tax terrorism” – these provisions are. Please help Digital India, Start-up India, Stand-up India and What-not India by scrapping this outrageous levy immediately.