In India a provision meant to curb money laundering is stifling startups. Can budget 2018 correct the mistake?
The previous year’s Budget may have drowned out the collective appeal to abolish angel tax for early-stage startups, but stakeholders are hopeful this year. With just days to go before Finance Minister Arun Jaitley makes his Budget address, startups and investors are congregating to demand complete abolition – or modification – of this tax structure.
As it stands today, funds from angels are subjected to over 30% tax if it is more than the fair market value (FMV). Introduced in Section 56 of the I-T Act in Budget 2012, it explicitly states that companies – from mature private enterprises to small startups – are liable to pay taxes on money invested as capital.
But, with most startups taking years just to break-even, treating part of the hard-earned cash that came in from angels as taxable income, even before a company begins to make money seems unwarranted.
Devil in the detail
This draconian tax – paradoxically named Angel Tax – is ill-famed for its reputation of driving away initial backers. Moreover, with VCs typically scouting for angel-backed startups, money from angels or non-listed entities becomes imperative for the growth of a company.
“Angels play a very important role in fostering the startup ecosystem,” says Siddharth Ladsariya, an angel investor who boasts of having many successful startups in his portfolio including Oyo Rooms and Myntra. “Angels step in at a time when a startup is in its most nascent phase, which is critical for its survival,” he adds.
Chimes in Mandar Gadkari, Head of Investor Engagement at Cross Border Angels (CBA), a San Francisco-headquartered angel investment group that is bullish on India: “Early-stage investors are more like mentors – they are actively hands-on with their investee companies. They also have the highest risk appetite amongst all categories of startup investments and hence, act as a confidence measure for other investors in the future.”
With a total repeal of this clause in the I-T Act is improbable since it was introduced to reign in undisclosed income, what are the alternatives that can be put in motion through Budget 2018?
Angels seeking wings
According to funding data from startup research firm Tracxn, there is a wide chasm between the number of angel investment rounds conducted in 2017 and the year before that.
Could angel tax be one of the reasons for this cautious sentiment among investors?
Possibly, prompting partner industry bodies and investors to look for solutions to protect angel investments. And recognising credible angel investors and allowing (tax-free) investments from only this accredited group is one of them.
“Any government body – be it DIPP or the Finance Ministry – can make distinctions between angel groups based on certain criteria or special parameters which can then be used to exempt them from paying tax,” suggests Indian Angel Network (IAN) co-founder, Saurabh Srivastava. “Section 56 was not designed to block genuine angel investments, but unfortunately, angel investors are suffering collateral damage,” he adds.
Siding with Srivastava is Senior Director and Head-Public Policy and Government Affairs at Nasscom, Bishakha Bhattacharya, who feels that just like there are metrics to recognise startups for tax benefits, a similar method can be devised to identify angel groups whose investments can then become eligible for tax exemptions.
“This can be undertaken under the Startup India program or can be led by a financial regulator,” says Bhattacharya. “One such criterion could be to impose a threshold on the amount of investments that can go tax-free. Then again, it is just one among the many scales that can be applied,” she adds.
Offering tax benefits to angels who fund small companies is another way.
“In most US countries, angel investors are incentivized by being awarded tax exemptions – or even tax benefits in some cases,” says Ladsariya. “This is necessary since angel investment is one of the riskiest investments undertaken,” adds Gadkari.
Innovation clause – what’s that?
The government had exempted investments made by Indian residents in ‘innovative’ startups from paying angel tax in Budget 2016. But, this certification depends on certain criteria outlined by the government – largely considered vague.
Here, the onus of recognizing a startup as “innovative” rested upon VCs, incubators and accelerators under the government umbrella. The revised definition as per DIPP guidelines may have widened the scope of startups considered innovative, however.
“The approach taken earlier limited a startup’s ability to justify its offering as unique unless validated by any of these institutions which may have had its own limitations and pressures to label a startup as innovative,” feels Gadkari. “On the reverse, many innovative startups – especially in tier 2 towns – may not have got access to such institutions which would have kept them out of key government schemes,” he adds.
According to him, the government can take a step further and add a few more specifics to the same to bring in clarity to the definition, such as, startups with:
- a) An inherent IP or patentable products
- b) Solutions that cause substantial reduction in cost, time and resources
- c) Products that bring in a Digital revolution for any sector (public as well as private)
- d) Services that help in skill building for any sector, faculty and age group.
Big price to pay
Picking up on the momentum created by a coalition of startup organizations, including Nasscom and IAN last year protesting against the imposition of angel tax, a slew of start-ups recently banded together to launch an online petition on Change.org seeking revision of the said tax structure.
“Rules and tools targeting undisclosed income are already in place and thus, government should begin with the assumption that there are genuine investors in the Indian startup ecosystem,” feels Gadkari.
Adds an employee who works at AnyTimeLoan, a fintech startup incubated at T-Hub, “The intent is to ensure quality fund flow through angel route and taxation is not the solution,” he says. “In fact, if angels invest in startups in specific sectors that create more employment or act as a catalyst in achieving larger national interests like financial inclusion, it should be taken out of the gambit of taxation,” he adds.
Source: The Economic Times