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India has fast-tracked creation of a framework for recognizing ‘investors’ funding startups that will shield them from tax issues along with providing other benefits.
- In a meeting called by the Department of Promotion of Industry and Internal Trade (DPIIT), the issue of creation of a framework for recognizing funding startups was discussed.
- The DPIIT is keen on putting in place a framework that will help startups raise funds without any hitch and save investors from facing any issues subsequently.
- The ‘accredited investors’, will be provided tax incentives for investments in startups.
- These accredited investors, which can include trusts, individuals, a family member of a startup and unlisted companies, may get an exemption from angel tax under Section 56(2) (vii)(b) of Income Tax Act, 1961, beyond the Rs 25 crore limits.
- The idea behind the move is that if a startup receives funding from a genuine, recognized investor then there is no fear of money laundering and hence the investment should not be scrutinized or face the so-called ‘angel tax’.
- The move comes after startups and some angel investors got caught in income tax crosshairs due to Section 56(2)(vii)(b) of the Income Tax Act, which provides that if a closely held company issues its shares at a price that exceeds the fair market value, the difference will be taxed as income from other sources.
- This provision, termed an anti-abuse measure, was introduced in 2012 to prevent money laundering via this route.
- It was dubbed the angel tax after several startups received notices under Section 56(2)(vii)(b) as their funding typically is more than fair market value.
As per Section 56(2)(vii)(b) of the Income Tax Act, if a company has issued shares to an angel investor at a price that’s higher than its fair market value, the extra amount received by the company will be taxed at 30.9 percent. The company would then have to pay income tax on that extra amount along with additional fines that the IT department might impose for the company trying to disguise the income as an investment.
- A startup can be defined as a human institution designed to create a new product or service under conditions of extreme uncertainty.
- In February this year, the DPIIT amended the startup framework, raising the limits for investments that would not be scrutinized for angel tax.
- The changes meant that a firm can be categorized as a startup even if:
- Turnover: If its turnover for any of the financial years since its incorporation hasn’t exceeded Rs 100 crore (a fourfold increase from the earlier cap of Rs 25 crore).
- Investment limit: The investment limit for exemption from this tax was raised to Rs 25 crore from Rs 10 crore.
- Besides, investments by listed companies with a net worth of Rs 100 crore or turnover of Rs 250 crore in an eligible startup will be exempt from the section beyond the Rs 25 crore limits.
STARTUP INDIA SCHEME:
- Startup India Scheme, launched in 2016, is an initiative by the Government of India for the generation of employment and wealth creation.
- Objective: Its goal is the development and innovation of products and services and increasing the employment rate in India.
- Benefits:Simplification of Work, Finance support, Government tenders, Networking opportunities, etc.
ANGEL TAX AND INVESTOR:
- Angel tax refers to the income tax payable on capital raised by unlisted companies through the issue of shares where the share price is seen in excess of the fair market value of the shares sold.
- The excess realization is treated as income and taxed accordingly.
- It is applicable only on individuals, investors, and not to venture capital funds
- Its major purpose was to prevent money laundering and investments made by AIF (alternate investment funds).
- It has come to be called angel tax since it largely impacts angel investments in startups.
- Though the government has taken various steps to shield startups and angel investors from “Angel tax” but it is not enough to protect startups.
- An angel investor is a wealthy individual who provides funding for a startup, often in exchange for an ownership stake in the company.
- Normally about 300-400 startups get angel funding in a year. Their investment in a unit ranges between Rs 15 lakh to Rs 4 crore.
THE GLOBAL SCENARIO:
- At the global level, more and more governments are recognizing the benefits of encouraging and inviting angel investors to boost their startup economies.
- To this end, many global startup hubs, offer amazing tax cuts and incentives to attract investors.
- China: China’s global presence is built on the backs of many startup ventures which offer amazing incentives.
- Singapore: Singapore also offers tax incentives to startups and investors, even offering qualifying startups up to Singapore $200,000 tax exemption on their first three consecutive years of assessment (YAs).
- Europe: In Europe, countries like Germany and the UK have passed laws and implemented policies to offer generous tax incentives to startups and angel investors.
- Australia: Across the world, Australia’s tax incentives for investment in innovative startups (introduced in 2016) have been called “arguably the most generous in the world”.
SIGNIFICANCE OF A DEDICATED FRAMEWORK:
- A Safety Cover: The accredited investor regime could provide cover for trusts, individuals and family members of a startup, as also unlisted companies that establish their bona fide.
- Gaining Trust:: The recognition framework will ensure the genuineness of investors, and therefore would not need scrutiny under this clause, which will further boost the confidence of the investor in the system.
- Increased Portfolio Investments: In India, Foreign portfolio investments are viewed as an integral part of the balance of payments and this scheme could be on the lines of one for foreign portfolio investors, which will boost Portfolio Investment in India.
In India, Startups have high expectations for the new regime. The new framework will recognize investors so that they won’t be subject to the so-called angel tax provisions on their funding of startups, and they will be able to fund startups without any limit. These changes are expected to soothe the nerves of all such start-ups which had been served notices under the Income Tax Act, 1961. With such initiatives, the Indian startup ecosystem will continue to grow manifold and carve out an ever-expanding niche for itself in the global ecosystem.