26-Jun-2019: Tax Exemption to Start-Ups

Startups receiving investments from Ventures Capital Fund are exempt from taxation as per provision of Section 56, (2) (vii b) of Income Tax Act 1961 (Act). Angel Fund is sub category of Ventures Capital Fund under Category-I Alternative Investment Fund (AIF), hence, eligible for the same exemption.

Several round of discussions have been held by Department for Promotion of Industry & Internal Trade (DPIIT) with the Startup ecosystem to address their concerns. Consequently, a notification number G.S.R. 127(E), dated 19th February, 2019 was issued by DPIIT. Central Board of Direct Taxes (CBDT) vide their notification number S.O. 1131(E) dated 5th March 2019 has notified that provisions of Section 56 (2) vii(b) of Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the said consideration has been received from a person, being a resident, by a company which fulfils the conditions specified in notification number G.S.R. 127(E), dated 19th February, 2019 of DPIIT.

Department of Revenue had earlier issued an advisory on 24th December, 2018 based on representations received from various startup companies that no coercive measures to recover the outstanding amount should be taken for startup companies, if additions have been made by Assessing Officer under Section 56(2) vii(b) of Income Tax Act, 1961 after modifying /rejecting evaluation so furnished under Rule 11 UA (2) of Income Tax Rule, 1962.

The provisions of the notification number G.S.R. 127(E) dated 19th February 2019 have been fully implemented, easing norms for providing tax relief to Startups on angel investments.

DPIIT accepts applications and declarations from Startups applying for Angel Tax Exemption and on the receipt of the same DPIIT forwards these applications to CBDT. As on 21st June, 2019 a total of 944 applications for Angel Tax Exemption have been received. Thirty-nine applications have been found to be incomplete, and 203 applications were repeat or modified applications. CBDT has exempted 702 startups under this provision.

7-Feb-2019: Effect of Angel Tax on Indian Startup Ecosystem

The Government of India has continuously engaged with all stakeholders to address relevant issues related to the Indian Startup eco-system.

The Department for Promotion of Industry and Internal Trade (DPIIT) issued notification in April 2018 for easing the norms for providing tax exemption to the Startup companies and further amended the notification on 4th February 2019.

As per the notification, an entity is considered as a Startup:

• Upto a period of seven years from the date of incorporation/registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India. In the case of Startups in the biotechnology sector, the period shall be upto ten years from the date of its incorporation and registration.
• Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded Rs. 25 crore.
• Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

Provided that an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.

A Startup which is recognised by DPIIT is eligible to apply for approval for the shares already issued or proposed to be issued if the following conditions are fulfilled

1. aggregate amount of paid up share capital and share premium of the startup after the proposed issue of share, if any, does not exceed ten crore rupees.
2. The investor or proposed investor shall have —
   1. returned income of Rs. 50 lakh or more for the financial year preceding the year of investment or proposed investment; and
   2. net worth exceeding Rs. 2 crore or the amount of investment made/proposed to be made in the startup, whichever is higher, as on the last date of the financial year preceding the year of investment or proposed investment.

Provided that in case the approval is requested for shares already issued by the Startup, no application shall be made if assessment order has been passed by assessing officer for the relevant financial year.

The application, accompanied by the documents specified therein, shall be transmitted by DPIIT to CBDT with the necessary documents. CBDT within a period of 45 days from the date of receipt of application from DPIIT may grant approval to the Startup or decline to grant such approval.

The Government has not conducted any survey to assess the adverse effects of angel tax on the Indian startup ecosystem.

22-Dec-2018: Angel Tax Controversy

The present government has always believed in 'minimum government, maximum governance’ and has given young population a level playing field to start their own business and created a eco system which allows them to grow. Over the past few weeks, several startups have reportedly been receiving notices from the I-T department asking them to clear taxes on the angel funding they raised, and in some cases, levying a penalty for not paying Angel Tax.

It all started by previous government which introduce section 56(2)(vii b) in 2012 to fight money laundering. This section was purely introduce so that the valuation of the company shall be at fair market value or any other method as adopted by AO.

What does the section 56(2)(vii b) say? If a company has issued shares to an angel investor at a price which is higher than its fair market value, the extra amount received by the company will be taxed at 30.9%. For example, if a company's shares are valued at Rs 100 each, and it sells them to an angel investor at Rs. 150 , the additional Rs. 50 would be treated as its income and not an investment. The company would then have to pay income tax on that extra Rs. 50 along with any additional penalty which IT department may impose.

Further startup has also received notices under section 142(1) of the I-T Act, which ask companies tax returns, creditworthiness, bank details and correspondence of angel investors who have put money in a startup. The assessing officer has to complete an assessment within 21 months of the end of the assessment year or 33 months of the end of the financial year.

But four years down the line in 2018, it's tougher for young people trying to start their own businesses as hundreds of startups have been served notices under a section of the Income Tax Act which has come to be known as the 'Angel Tax', under section 56(2)(vii b) and Section 142(1). The sudden demand for additional documents increases compliance costs for startups, who are usually struggling with finance and time.

Valuations of startups conducted by experts or chartered accountants were based on assumptions and future growth projections provided by the founders, which were achieved or not achieved in actuality. The tax department has started issuing notices on these valuations to the experts or chartered accountants now, and sought explanations on these assumptions and projections, which happen to be the controversy around angel tax Income-tax officers claim that the scrutiny on startups is mainly due to concerns that black money may have changed hands and are investigating if some of these investments were for converting black money (unaccounted money) to white (legal money).

In a notification dated May 24, 2018, the Central Board of Direct Taxes (CBDT) had exempted angel investors from the Angel Tax clause subject to fulfilment of certain terms and conditions, as specified by the Department of Industrial Policy and Promotion (DIPP).

Startups have been asked to register with the Department of Industrial Policy & Promotion (DIPP) to avoid getting such tax demands. However, only those companies which are less than seven years old, have never had an annual turnover of more than Rs. 25 crore and did not get more than 10 crores in total from angel investors qualify as startups. This means that startups who have done well with more than 25 Crore turnover are automatically disqualified. Media reports suggest even startups who are registered with DIPP have received notices.

The Central Board of Direct Taxes (CBDT) said in a recent statement that no coercive action related to tax demands would be made till the time an expert panel resolved the issue of taxing startups. CBDT recognizes that startups are going to bring a lot of innovation to the country and, therefore, have to be supported in every possible manner.

The startup ecosystem has created thousands of new job from e-commerce firms to food delivery apps. CBDT and government in desperate for more taxes are discouraging startups as most of the entrepreneurs who have received notice are spending lot of time and efforts in replying and making assessing officer understand valuations for startup. If entrepreneur has to spend so much time on compliance of taxes then how they are going to run the business? Many entrepreneurs are now considering registering their companies overseas in countries like Singapore. In many cases, the tax liability far exceeds the capital available with the company and many entrepreneurs are left with no option but to seriously consider a shutdown.