Here's how new Angel Tax tweaks hit startup fundraising

For investments in unlisted Indian businesses, investors from 21 nations, including the US, the UK, France, Australia, and Japan, are free from the application of the angel tax. The majority of foreign direct investment in India comes from nations like Singapore, the Netherlands, and Mauritius; nevertheless, these nations are not on the list of excluded countries.

The Central Board of Direct Taxes (CBDT) announced a list of excluded entities in a notification dated May 24. These entities include those registered with Sebi as Category-I FPIs, Endowment Funds, Pension Funds, and broad-based pooled investment vehicles where the number of investors in such vehicle or fund is greater than 50, as well as the citizens of 21 specified countries, including the US, UK, Australia, Germany, and Spain.

Austria, Canada, Czech Republic, Belgium, Denmark, Finland, Israel, Italy, Iceland, Japan, Korea, Russia, Norway, New Zealand, and Sweden are among the other countries included in the notification.

The announcement followed a press release from CBDT on May 19 that listed the categories of investors exempt from the angel tax provision. Stakeholders must now wait for a formal notification regarding the valuation criteria, for which the press release from last week listed five methods.

Government and government-related investors such as central banks, sovereign wealth funds, international or multilateral organisations or agencies, including entities controlled by the government or where direct or indirect ownership of the government is 75% or more, as well as banks or entities involved in the insurance business, where such entity is subject to applicable regulations in the country where it is established, incorporated, or is a government-related investor, are examples of other exempt entities.

Though the exclusion of Mauritius, Singapore, and the Netherlands is thought to be an effort to close loopholes from investments resulting from these tax havens, experts also believe that the exclusion of these nations will have an impact on startup fundraising as these countries make up a significant portion of their investment sources.

Section 56(2)(viib) of the Income-tax Act had been modified by the Finance Act of 2023.

The clause, also referred to as the “angel tax,” was initially implemented in 2012 to prevent the creation and use of unexplained funds through the purchase of shares of closely held businesses at a price over their fair market value.

According to the provision, if an unlisted company, such as a start-up, receives equity investment from a resident for the issuance of shares that exceeds the face value of those shares, it will be counted as income for the start-up and subject to income tax under the head “Income from Other Sources” for the applicable financial year.

The government recently suggested expanding the scope of the law to include overseas investors, which means that any money a start-up receives from a foreign investor will now be considered income and subject to taxation. The angel tax fee was not applied to startups that received DPIIT recognition.

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