Budget 2023 Expanded Scope Of Angel Taxes To Cover Foreign Funding: Will It Derail Start-Ups During The Funding Winter?

Angel taxes have been a major bone of contention between start-ups and governments over the last decade. 

Introduced in 2012, they aimed to prevent black money laundering through share sales. However, changes were made over a period of time to allow certain exemptions that wouldn’t make angel tax an impediment in fundraising for small and mid-sized start-ups. 

Angel taxes so far had applied only to the money raised from residents i.e. domestic investors. But in the 2023 budget, the government also made changes to allow taxation of the funds raised from foreign investors.

Why are Angel Taxes Imposed?

The use of shell companies has been widespread in India. One means of transferring black money could be using the shares of a bogus company. Simplistically, people could invest in shares of bogus companies, effectively transferring black money from one person to another under the guise of angel investment without being penalised. 

The introduction of an angel tax meant that the company that received money, would have to pay a tax on the money it received – thus, penalising anyone who used these means to circumvent the law.

Government Has Tried to Make Life Easier for Start-Ups

While the angel tax was introduced for a good cause, India’s small start-ups certainly find it burdensome when since they might have to pay out a significant chunk of the money received from investors as tax. And though the money was raised for running operations, it had to be paid to the government – limiting the amount of capital available for start-ups. 

The government has realised these issues and has introduced various measures to make these transactions easier by issuing exemptions.

In addition, start-ups registered under the Department of Promotion of Industry and Internal Trade (DPIIT) do not attract angel tax. Nevertheless, introducing an angel tax for funds from foreign investors would mean that companies would have to pay some tax on the premium whenever a deal is made above the fair market value of the shares.

The Question Of Fair Market Value

The fair market value is another conundrum that start-ups would have to face since valuations have been running ahead of actual numbers in the private markets over the last few years. 

A significant deviation in valuations and actual numbers can attract the attention of authorities, adding to start-ups’ worries. Further, angel taxes apply to individuals, and their ticket sizes are unlikely to be very large.

On the other hand, the exemptions are still valid, which wouldn’t create issues for the start-ups that fall within those conditions. For instance, most new start-ups would qualify for one of the exemptions mentioned above, while mid-sized start-ups might struggle with taxation issues.

Ultimately, the effect on start-ups will only be determined by the implementation of the rules. 

If the government gives companies some leeway, instead of by-the-letter enforcement, these companies might not be as affected by the new laws. On the other hand, if inconvenienced excessively, companies could shift to other locations that are more tax-friendly than India. 

Many large and small start-ups with operations in India are already registered outside India for tax or legal reasons. While some companies like PhonePe have returned to India, these are exceptions rather than the rule. 

Currently, start-ups have been struggling to raise funds or sustain valuations, and the introduction of these taxes might make life a little difficult for them.