Repeal The Angel Tax, Recent Changes Aren't enough

The cry for relief from the angel tax is not about a tax holiday being disallowed, but about addressing the difficulty new ventures face in securing appropriate funding

The Government’s “Startup India” initiative continues to receive flak as the startup ecosystem faces new hurdles, and the ‘angel tax’ controversy affects access to capital. In the last 24 hours, at least two startups have complained that their company accounts were frozen by the tax department and money was withdrawn on account of angel tax demands. This warrants not just a review of angel tax but a full repeal.

The tax backstory

The angel tax dates back to the Finance Bill of 2012 where Section 56(2)(viib) of the Income Tax Act, 1961 was introduced with the purpose of curbing money laundering via inflated share price issuance. It is the tax levied by the government on any private company that raises capital above its fair market value. The difference between this FMV and the price at which the shares are issued is deemed as income (from other sources) and taxed at the maximum marginal rate.

The angel tax controversy has centered around valuations arrived at during various rounds of startup funding. This has been a problem for entrepreneurial ventures as there is no definitive or objective way to measure a startup’s ‘fair market value’. The determination of this FMV is based on two valuation methodologies: net asset value and discounted cash flow basis. The Department of Revenue has lately started assessing the value of startups based on their net asset value. While the well-intended objective seems to be to crack down on black money, genuine startup funding transactions have come under the scanner of the taxman.

Several startups have found it difficult to justify the higher valuation to tax officials.