Why Not Make It Easy For "Angels" To Invest In Start-Ups?

When will the “enabling provision” introduced by Pranab Mukherjee, to provide some relief to start-up companies and investors, be taken forward?

In my previous article “Understanding Start-up Tax”, with reference to the Tehelka case, I gave you an overview of the concept of “start-up tax” i.e. “tax on premiums received in excess of Fair Market Value (FMV) of shares”, the reason it was introduced and why it should not be purged. The current article is an analysis of what could be the feasible solution to address the complex problem of retaining the dubious transactions as in the case of Tehelka, under the tax net, while ensuring that genuine start-up companies are exempted.

Before getting deeper into the analysis part, we need to look into some basic facts. The proposal to tax the share premium received in excess of the Fair Market Value (FMV) of the shares was put forth in the Budget 2012-13 by the then Finance Minister Pranab Mukherjee.

Immediately after the then Finance Minister’s proposal to tax the share premium received in excess of FMV of the shares, concerns were raised from various sections that this “tax” would hamper the ability of start-up companies to seek investments. Representations were made by “Indian Angel Network”- a collective body of “Angel Investors” & Nasscom- the software lobby group, to the Finance Minister to exempt start-up companies from this “tax”.

The Finance Minister too, in his speech at the Parliament on 7th May 2012, while moving the amendments to The Finance Bill, 2012 acknowledged the fact that he received representations from “Angel Investors”. An extract of his speech is as follows:

“It has been proposed in the Finance Bill that any consideration received by a closely held company in excess of the fair market value of its shares would be taxable. Considering the concerns raised by “angel” investors who invest in start-up companies, I propose to provide an enabling provision in the Income Tax Act for exemption to a notified class of investors.”

Thus, in order to address the concerns raised by the “Angel Investors”, Pranab Mukherjee proposed to provide an enabling provision to exempt a class of investors. The list of such “class of investors”, who would be exempted by this enabling provision, had to be notified by the Central Government through a separate notification. The assurance of the Finance Minister was that, under this enabling provision, “Angel Investors” would be notified as exempted class of investors.

The Finance Bill, 2012 received the assent of the honourable President on 28th May 2012 and became an “Act”. As promised by the then Finance Minister, the Act carried an enabling provision to exempt such class of investors as maybe notified by the Central Government.

Now, the only thing that was pending was the notification of “Angel Investors” as an exempted class of investor. This notification is to be made by the Ministry of Finance by publishing it in the “Official Gazette” which has not been done till date.

On 26th June 2012, Pranab Mukherjee resigned from the government so as to get elected as the President Of India. His successor P Chidambaram, for reasons best known to him, was not quite keen on following this issue up and hence didn’t take any steps to get the “Angel Investors” notified under the exempted class of investors.

Until now the “enabling provision” that was introduced by Pranab Mukherjee, with the prime motive of exempting the investments made by “Angel Investors” in the start-up companies remains ineffectual.

To add more misery to the start-up companies, there is another provision which asserts that the Fair Market Value (FMV) of the shares has to be substantiated to the satisfaction of the Assessing Officer (of The Income Tax Dept). If the company fails to substantiate it, then the FMV could be arbitrarily decided by the AO. Going by the allegations of the business groups, this arbitrary power is being misused by the AOs either to extract bribe or in forcing the start-up company to pay exorbitantly high taxes.

If the present government is serious on addressing the complexities faced by start-ups it should:

1. Either notify “Angel Investors” under the exempted class of investors category or it should give a blanket exemption period of (say) 3 years to start-up companies from this Tax. I prefer the latter because some “Angel Investors” invest not only in start-ups but also in existing companies. If the Angel Investors were to be notified as “exempted class of investors” then their investment in other than start-up companies (i.e. existing companies) will also go untaxed.

2. Cut down the arbitrary powers given to AO.

It was expected that the provision relating to start-up tax would be appropriately amended in the Budget 2015-16 so as to offer the much needed respite to start-up companies, which hasn’t happened yet.

The Finance Bill, 2015 has already been introduced in the Lok Sabha but it’s not too late yet. The government can make use of the “enabling provision” and notify “Angel Investors” as the exempted class of investors in the “Official Gazette”. This may provide interim relief for start-up companies till such time the provision relating to start-up tax is suitably amended. Also, this will give a clear message that the government is committed towards clearing unwanted regulatory hurdles that hamper the ease of conducting business in India.