Startups are known for their innovative and disruptive ideas that have the potential to change the world. However, setting up a business from scratch requires a considerable amount of investment, and this is where angel investors come into the picture. Angel investors, also known as private investors, invest their own money in startups in exchange for an ownership stake.
Is Angel Tax A Hurdle For Startups?
While angel investors are essential for startups, the concept of Angel Tax can create hurdles for entrepreneurs. Angel Tax is a tax levied on the excess capital that a startup raises through the issue of shares to its investors. The tax can be as high as 30%, and it applies to any amount raised above the fair market value of the shares.
The primary purpose of Angel Tax is to prevent money laundering, but it has turned into a massive headache for startups. The tax has been criticized for being unfair, and it has hindered the growth of many startups. This is why it is essential for startups to save on Angel Tax.
One way to save on Angel Tax is by ensuring that the startup's valuation is reasonable. Startups often overvalue their business to attract angel investors, but this can backfire when it comes to paying Angel Tax. It is essential to get the valuation right and to avoid raising capital at a premium that is higher than the fair market value.
Another way to save on Angel Tax is to ensure that the startup is registered as a private limited company. The government has provided exemptions for Angel Tax for startups registered as private limited companies, provided that they meet certain criteria.
How To Save On Angel Tax? Experts Talk
TICE News spoke to some of the prominent Venture Capitalists in the country to know how can startups save on the Angel Tax.
Mr Anil Joshi, Managing Partner at Unicorn India Ventures says, “The Angel Tax is levied on the companies (startup) on the net investments in excess of the fair market value under section 56 (2)(viib) and the same was introduced into act in 2012.
The startups which raises money at value excess of the fair market value are subject to Angel tax as it is considered as income in the hands on the startups under section 56 (2)(viiib).
Not all startups are subject to Angel Tax, the startups which are not registered under DIIP as startups and doesn’t have the enterprise valuation certificate from the certified valuer are subject to Angel Tax. The startups which are registered under DIIP as startups and have valuation certificate from certified valuer are exempted from angel tax, he pointed.
Mr Vinod Bansal, Co-founder & CFO, Inflection Point Ventures, says “Depending on the country or region, some startups may be eligible for tax exemptions or benefits. In India, if a company is a DPIIT recognised startup and has obtained angel tax exemption, subject to fulfilment of eligibility criteria for availing exemptions u/s 56(2)(vii)(b) of the Income Tax Act, it shall be exempted from Angel tax.”
He advises the startups to set a realistic share price. “To avoid a high Angel Tax, startups should set a realistic share price which is in line with the valuation of the company,” Mr Bansal says.
On raising funds through AIFs, Mr Bansal says that the Investments made by Category I AIFs, which are registered with SEBI, are exempted from Angel Tax.
“Startups can consider seeking investment from accredited investors who meet the criteria to save the tax. Consider other sources of funding: Startups can also consider other sources of funding such as crowdfunding for Non-Profit Organizations and specific grants approved by the government that do not attract Angel Tax,” he suggests.
Why Is It Important to Save Angel Tax?
Startups, dependent on angel investors for funding, face hurdles due to Angel Tax, which is levied on excess capital raised through share issuance. To avoid this, startups should ensure their valuations are reasonable and the company is registered as a private limited company to meet criteria for exemptions.
It's also essential to pay Angel Tax to demonstrate compliance with the law, maintain reputation, and avoid legal and financial troubles. Advice from Venture Capitalists includes setting realistic share prices, seeking investments from accredited investors, and considering other sources of funding like crowdfunding or government-approved grants.