Business Today

Prolonged Angel Tax woes could derail Startup India forever, start-up founders warn PM Modi

In the two-page letter seen by Business Today, start-up founders have cautioned the government that if the issue is not resolved immediately, Modi's 'Startup India' movement could be derailed forever.

Rukmini Rao | January 17, 2019 | Updated 00:31 IST
Prolonged Angel Tax woes could derail Startup India forever, start-up founders warn PM Modi

Nearly 70 start-up founders and Indian software product consortium iSPIRT, have written a letter to Prime Minister Narendra Modi seeking immediate intervention on the ongoing 'Angel Tax' tussle between the income tax department and start-ups. In the two-page letter seen by Business Today, start-up founders have cautioned the government that if the issue is not resolved immediately, Modi's 'Startup India' movement could be derailed forever. With close to 39,000 start-ups having raised around $38.5 billion in the last four years, start-up community has claimed in the letter to have created a value of close $130 billion dollars in India along with ample employment opportunities. The letter has also quoted a survey by LocalCircles, where 38 per cent of start-up founders have admitted to have received one or more IT notices in 2018, making the situation grave compared to last year.

Why start-ups are feeling harassed?

Section 56 and 68 of the IT act, empowers the department to demand taxes from start-ups for money raised by them from individuals (angel investors) for issuance of shares (at a premium value) above the 'fair market value'. The valuation being subject to a report by a merchant banker, which either applies the net asset value method or the discounted free cash flow method. The start-ups will also have to furnish information of the investors including personal details like IT returns and net asset value of the investor to satisfy the assessing officer, to consider the investment as a bonafide transaction.

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The entire 'Angel Tax' issue started precipitating two years ago, when start-up founders were sent demand notices by the Income Tax department, mainly under section 58 to clear the dues. The notices sought founders to pay the difference between the fair value and the premium at which the amounts were raised from angel investors though share sale. Sreejit Moolayil, co-founder of True Elements says, "Start-ups in an angel round typically raise around Rs. 50 lakhs to 2 crore and not more. With most companies dying within 1000 days of starting up, getting a notice after 3 years makes no sense". With DCF or discounted cash flow method not widely accepted by the assessing officers, "The junior officers are thinking that if we have raised money from angel investors, it's a doubtful transaction" he adds.

At around the same time last year, when start-up companies started receiving notices, India's noted angel investors like Kris Gopalakrishnan, Mohandas Pai and Indian Angel Network (India's largest angel network forum) had raised their concern with the commerce ministry, DIPP and also Finance ministry over the provisions.

"When we sent a representation to the government last year, they assured that there would be no coercion and again it has come up now with the next year's assessment being done by the department," said Mohandas Pai, Founder, Aaron capital.

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As a quick fix remedy, several notifications with clarifications have already been issued till date either by the DIPP or CBDT. The notification issued in April 2018, mandated start-ups not only to register with DIPP but also seek approval from the inter-ministerial board or IMB before raising funds to keep the investment off IT radar. Where time is of the essence for an early stage start-up, how can one wait for government approvals asks Abey Zachariah, CEO, GoodBox?

"When someone is willing to fund a brilliant idea, should a founder start work or should he take approval from IMB before starting work and then receive fund to start work? " he asks. Most start-up founders say that with the inter-ministerial board sitting just once a month for clearances, the waiting period for approval is anywhere between 3-6 months. This period can be a death nail for early stage start-ups that are looking for survival through angel investment and bring the company to some scale for the next round of funding.

Even if we are to go by the government's own status report, though DIPP has recognised a total of 14,036 start-ups under its umbrella, a mere 91 start-ups have been approved for availing tax benefits by IMB, as of 3rd week of November 2018.

According to a group of six start-up founders, who are spearheading the movement to end this law, of which Sreejit is also a part, over 2000 notices have already been slapped this year.  But the problem lies very much at the heart of the Income Tax Act.

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"The recent DIPP circular cannot override the section," says Pankil Sanghvi, Partner, Tax and Regulatory Services, BDO. The underlying question of veracity of valuation still needs to be addressed and till then the tax officials are well within their rights to recover the dues, by the letter of the law. "If a start-up company wants they can challenge this in a writ petition and at the jurisdictional high court or the CIT appeal and then ITAT like any regular tax appeal," he adds.

In the present scenario the intended sections were never meant to be applied to start-ups. "When a tax is unfairly applied the only remedy is take it off the law. The other reason being, now with GAAR under Indian law effectively dealing with malafide transactions, the utility of the clause in under 56 and 68 simply does not exist," says Vivek Gupta, Partner and head, M&A, KPMG India.

The problem for start-ups is not just the cumbersome compliance process but also lack of understanding on the part of policy makers and tax authorities on how start-ups work. More over these provisions are attracted by start-ups registered in India and angel investors in India, making this unfairly skewed in a rather flattish start-up world where big ticket funding are coming from foreign investors.

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"Out of the $13.7 billion dollars funding that India got last year, only 10 per cent camefrom India, we are on the way to becoming a digital colony. If you go after angels who are investing, they will simply stop investing," says Mohandas Pai.

Industry experts believe that intervention by the government should be minimal. "Most of the start-ups, if they get funding and they are successful, are already doing several filing under various laws. The data is already available with the regulators to take action against errant," says Vikas Vasal, Partner, Tax, Grant Thornton LLP India. "If we have to encourage entrepreneurship to increase employment, these kinds of cases become a deterrent," he adds.

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