Guide on Angel Tax for Startups

Startups are eligible for a variety of tax advantages, contingent upon meeting specific criteria. The Start-up India Initiative, which supports the development of start-ups in India and promotes entrepreneurship, was officially launched on January 16, 2016.

This document covers

1. Angel Investor
2. Angel Tax
3. Persons required to pay Angel Tax
4. Rate of Angel Tax
5. Exemptions from Angel Tax
6. Process of claiming exemption from Angel tax
7. Amendments w.e.f Finance Act 2023

1. Angel Investor

"Angel Tax" and "Angel Investor" have gained considerable traction among startups in recent times.

An angel investor is defined as an individual or organization that offers to provide financial support to a startup in the form of ownership interests, convertible debt, or equity.

In general, angel investors allocate their capital towards initial phases of enterprises characterized by elevated levels of risk. In contrast to venture capitalists, angel investors invest primarily with their own funds in enterprises.

2. Angel Tax

• Early stages of operation require capital for every business. Angel investors may provide financial support to a nascent enterprise in return for convertible debt or equity.
• Angel tax refers to the tax liability that a closely held company is subject to under section 56(2)(viib).
• In the event that the following requirements are met, the corporations are obligated to remit tax on the surplus premium acquired from the sharing offering.
  
  
  • A closely held company should give out equity or preference shares.
  • Receiving money in exchange for shares can come from anyone.
  • The money that was given in exchange for shares is more than their face value and their fair market value.

3. Persons required to pay Angel Tax

Angel Tax is a tax that startups and other companies that sell shares for more than their fair market value must pay.

4. Rate of Angel Tax

"Income from Other Sources" includes the premium the company got that was more than the fair market value of the shares. This premium is taxed at 30% plus an education cess.

5. Exemptions from Angel Tax

If a startup that has been approved by the Department for Promotion of Industry and Internal Trade (DPIIT) meets the following requirements, it will not have to pay the Angel Tax:

5a. Paid Up Capital

The Aggregate amount of paid-up capital and share premium including the proposed issue of shares should not exceed Rs 25 crore. The issue of shares to the following persons shall not be included while calculating the threshold.

• A Non-Resident Person
• Venture capital company or Venture Capital Fund
• Listed Company whose networth exceeds Rs 250 crore for the financial year in which the shares are issued.

5b. Utilisation of Funds

The eligible startup should not invest in any of the following assets for a period of 7 years from the end of financial year preceding the year in which shares are issued.

• Land or building, being a residential house, other than that used for the purposes of renting or held as stock-in-trade in the ordinary course of business.
• Land or building, not being a residential house, other than that occupied by a start-up for its business or renting purposes or held as stock-in-trade in the ordinary course of business.
• Loans and advances, if a start-up is not engaged in the ordinary business of lending of money.
• Capital contributions to any other entity.
• Shares and securities
• Motor vehicle, aircraft, yacht, or any other mode of transport, if the cost of such an asset exceeds Rs. 10 lakhs other than that held by the Start-up for the purpose of plying, hiring, leasing, or as stock-in-trade in the ordinary course of business.
• Jewellery held otherwise than as stock in trade.
• Archaeological collections, drawings, paintings, sculptures, any work of art or bullion.

Note: If the startup invests in any of the assets before the end of 7 years from the end of latest financial year in which the shares are issued at a premium, exemption provided shall be revoked with retrospective effect.

6. Process of claiming exemption from Angel tax

• The startup has to file a declaration in Form 2 with DPIIT along with details of the company like name, date of incorporation, registration/incorporation no, contact details etc
• A self-declaration form has to be attached in PDF Format and it should be printed on company’s letterhead and digitally signed by authorised signatory.
• The DPIIT shall forward the self-declaration form to CBDT for approval.
• The startup can issue the shares after submitting the self-declaration form.
• The CBDT shall assess the application and it can either accept it reject it after giving an opportunity of being heard.

Recommended: You can talk to an EZTax expert about Angel Tax and Startup Investments right now to get a personalized view.

7. Amendments w.e.f Finance Act 2023

Finance Act 2023 has amended some of the provisions of section 56(2)(viiib) of Income Tax Act 1961. The Amendments are as follows.

1. The Finance Act 2023 has included the foreign investors also under the ambit of Angel Tax. Earlier the investment received from foreign investors is not taxable as Angel Tax. As per changes in Finance Act 2023, now the investment from foreign investors in excess of fair market value of shares is also taxable.
2. Valuation Rules i.e., Rule 11UA has been amended. The following valuation methods are added
   
   
   1. Discounted Cash Flow (DCF)- Existing
   2. Net Asset Value (NAV) method- Existing
   3. Comparable Company Multiple Method
   4. Probability Weighted Expected Return Method
   5. Option Pricing Method
   6. Milestone Analysis Method
   7. Replacement Cost Method