DIPP in its recently issued notification, which is effective 11th April 2018, does not require start-ups to be incorporated on or after 1 April 2016 for the purpose of exclusion from angel tax provisions. The notification has introduced procedural guidelines to be followed to avail a tax holiday and seek exclusion from angel tax by start-ups. In the context of exclusion of start-ups from fair valuation rules for issue of shares, DIPP has notified twofold conditions to be fulfilled for obtaining IMB approval.
The recent development by DIPP has finally given some relief to Indian Startups. The relaxation has been given to a contentious tax rule and allowed startups set up after April 1, 2016 to qualify for tax exemptions if their total funding is less than Rs 10 crore and their revenue is less than Rs 25 crore.
The Government has also put in place a mechanism for such companies to secure exemption from the ‘angel tax’ with retrospective effect and avail tax incentives under its startup policy.
Startups are of great significance for any economy as they are collectively a major emerging source of revenue and employment. Many governments from across the world have been going out of their way to facilitate entrepreneurial dreams. India took initiative to support startups by means of its flagship ‘Make in India’ programme. A plethora of other schemes viz ‘Startup India’ has been launched, but the “Angel tax” haunts startups and angel investors. The issue took a serious turn last year when several startups faced scrutiny from Income Tax department with regard to capital raised at very high valuations.
“ Department of Industrial Policy and Promotion has announced “waiver conditions” for “Angel tax”. Start-ups from now on may avail of the tax concession only if total investment, including funding from angel investors (those who make the initial equity investment) does not exceed Rs.10 crores. ”
What is Angel Tax?
The concept of ‘Angel Tax’ was first introduced under the Finance Act 2012. Simply put, the angel tax is a tax levied on investments made by external angel investors in startups or Hedging companies. Angel tax is applicable on the capital raised by unlisted companies from individuals against an issue of shares in excess of the fair market value. Such income has been classified as ‘income from other sources’ under Section 56 (viib) of the Income Tax Act. For example, if a startup whose shares are valued at INR. 100 and receives INR 150 from investors for the same then INR 50 will be subject to angel tax at the rate of 30.9%. This was targeted to tackle possible money laundry through high premium on shares.
Background
In 2016, the Central Board of Direct Taxes (CBDT) issued circulars to exempt eligible startups from angel taxes, even if the funding raised by a startup was in excess of fair market value. But this was not as lucrative as it seemed to be. Whether a startup is innovative or not, currently depends on a certification by the Department of Industrial Policy and Promotion (DIPP). This has led to several companies not being incubated inside government registered incubators or eligible for government grants. To be recognized as startup, as per government norms, it must not be older than seven years and must have an annual turnover that does not exceed INR 25 Crore. Most of the startups still had to pay angel taxes as most were not officially recognised as startups.
DIPP’s move- Boom for startups which are born after April, 2016
Department of Industrial Policy and Promotion vide notification G.S.R.364(E) dated 11th April, 2018 superceeding notification no. G.S.R. 501(E) has specified conditions for availing the “Angel tax” exemption on shares issued by start-ups over the fair market value. The notification has set out major relief to the start-ups following the stickling conditions to be recognised as “Start-up”. DIPP has also constituted a broad-based inter-ministerial board to look into the applications for claiming the tax exemptions.
Who will be qualify as a “Startup”?
An entity shall be considered as a Startup:
i. if it is incorporated as a-
a. private limited company (as defined under Companies Act, 2013);
b. registered as a partnership firm (registered under section 59 of the Partnership Act, 1932);
c. incorporated as Limited Liability Partnership (under the Limited Liability Partnership Act, 2008);
ii. seven years has not elapsed since the date of its incorporation or registration (in case of biotechnology sector, the period shall be up to ten years from the date of incorporation/ registration);
iii. turnover of the entity for any financial year since incorporation/ registration has not exceeded INR 25 crores;
iv. 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’.
An entity shall cease to be a Startup on completion of seven years from the date of its incorporation/ registration or ten years, as the case may be, or if its turnover for any previous year exceeds Rupees 25 crore.
Who can avail tax exemption under clause (viib) of sub-section (2) of section 56 of the Act
“A Startup” can apply in FORM 2 along with requisite documents to avail tax exemption if the following conditions are fulfilled:
I. the aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed ten crore rupees,
II. the investor/ proposed investor, who proposed to subscribe to the issue of shares of the startup (hereinafter in this notification referred to as “investor”) has, —
a. the average returned income of twenty-five lakh rupees or more for the preceding three financial years; or
b. the net worth of two crore rupees or more as on the last date of the preceding financial year, and
c. the startup has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.
Tax benefit under Section 80- IAC of the Income Tax Act, 1962 (the act)
A Private Limited Company or Limited Liability Partnership incorporated on or after 1st day of April 2016 but before 1st day of April 2021 can apply to the CBDT in FORM 1 to avail certificate for claiming 100 per cent tax exemption under Section 80- IAC of the act on profits for any three consecutive years out of the initial 7 years of the start-up.
Conclusion
The abolition of the angel tax is a welcome move. However, The conditions specified in the notification increased the compliance burden on the start-ups as such they will have to file forms for claiming profit linked tax benefits and angel exemption in addition to registration with DIPP. Further, as the approval from Inter-Ministerial Board would specify details of proposed investors, every funding from a new investor would require fresh approvals from the Board. This would mean the majority of such investments get no relief those incorporated before April 1, 2016, are not eligible for such breaks and will therefore also not be eligible for exemption from the angel tax. The government however, further modifies the criteria they plan to set for clearance by the IMB for exemption from Section 56. If the criteria doesn’t become relaxed, the start up dream will not become a reality. The need of the hour is to make the rules less, not more, onerous and bureaucratic and more transparent.
Industry experts opine that currently it as a partial relief only and fear that this might just slow down the entire process altogether. “This is definitely a good move by the government, which comes with a mechanism to help genuine startups. There is a procedural layer that has been introduced and we hope it works. The only caveat is that approvals should not too long and should not be cumbersome.
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Acquisory News Chronicle-April 2018
