23 January 2019
DIPP Notification for Providing Angel Tax Exemption to Start-ups – Whether Relief in the True Sense?
The government has approved a DIPP (Department of Industrial Policy and Promotion) notification easing out exemption provisions from the angel tax net. ‘Angel tax’ is the term coined for the tax levied in the hands of start-ups on premium received in excess of fair value for issue of shares. This is an anti-abuse provision introduced vide Finance Act, 2012 effective 1 April 2012 to curb share issuance at an excessive premium and applies to all unlisted companies. In the context of start-ups, the said tax is commonly referred to as angel tax.

As part of the ‘Start-up India Initiative’ to encourage budding entrepreneurs, ‘Start-ups’ meeting the definition criteria recognized by DIPP have been exempted from the applicability of this provision, subject to satisfaction of the stipulated conditions. However, the conditions prescribed have been extremely cumbersome to comply with which had a dampening effect on the objective sought to be achieved through this initiative.

A lot of concerns were raised in this regard by various start-ups and the investor community. To address these concerns, DIPP has released an amended notification, subject to the government review, easing out the procedural requirements and conditions. The government has reviewed and approved the notification. However, a formal notification is still awaited in this regard.

A comprehensive analysis of the revised set of conditions vis-à-vis present ones are hereunder:

Particulars Present conditions[1] Revised conditions[2] SKP comments
Application for exemption approval

Application for exemption approval to be made to the Inter-ministerial Board

Now it shall be made to DIPP. DIPP shall transmit the application to CBDT

This is a positive move. Considering the high-profile constitution of the Board, their availability for quick disposal of the application could have been a challenge.
Thus, changing the approval authority and defining a timeline would certainly help in timely clearance of the applications.
However, no application can be made where the shares have already been issued and the assessment has been completed for the said year.
Time line for processing of application

No time line was prescribed earlier

CBDT to grant/decline approval within a period of 45 days

Limit on share capital and share premium after proposed issue Not to exceed INR 100 million

No change

The present limit prescribed appears on a lower side. This should be increased to atleast INR 500 million
Conditions on Investor/proposed investor:

i. Average returned income of INR 2.5 million or more for preceding three financial years;

ii. Net-worth of INR 20 million or more on last date of preceding financial year

To be seen only for preceeding financial year. Furthermore, limit increased to INR 5 million.
Net-worth limit to be higher of INR 20 million or amount of investment made or proposed to be made
The limit should have been set for the overall income irrespective of its taxability.
Also, the conditions are cumulative. Thus, it appears that the objective is to mandate use of own funds/investor to be self-sufficient in funding the investment

Valuation report

Mandatory requirement of obtaining report from a Category I Merchant banker for valuation as per Rule 11UA of the Income Tax Rules, 1962 Requirement done away with

This is a welcome change. The requirement to obtain a valuation report was compelling the start-ups to indirectly comply with the requirements of the provision making the benefit sought to be granted ineffective.
[1] Gazette Notification No. G.S.R. 364(E)dated April 11, 2018
[2] Gazette Notification No. G.S.R. 34(E)dated January 16, 2019
SKP Comments
This notification seeks to ease out the procedural requirements for the start-ups raising funds from angel investors. The present conditions were perceived to be non-conducive for the growth of start-up ecosystem. In that sense, changes such as making the process time bound, removal of valuation requirement etc., are encouraging and would boost the sentiments of the start-up fraternity. The relaxation in the condition of minimum average returned income from the past three years to just one year is also a fair proposal.
In the same breath, in our view, retaining the capital limit to merely INR 100 million and making cumulative conditions for investors need reconsideration. These conditions do not seem to be in sync with the practical realism where an investor may have an overall high income but taxable returned income may be low. Furthermore, the requirement of increasing the net-worth limits to INR 20 million or investment amount, whichever is higher, may put the capable investors who can easily raise funds to a disadvantage. Also, while the time limit for disposal of application has been specified, there is no time-limit prescribed for transmission of the case from DIPP to CBDT. It could be because the DIPP might be expected to play the role of just an intermediary for channelizing the applications to the CBDT. Thus, the transmission of applications is likely to happen without much time lag. However, should there be any delay at the end of the DIPP in transmitting the application to the CBDT, the objective would not stand served. Another point to ponder here is whether in the first place there was any need for keeping DIPP as the application authority as in any case the application is to be dealt with by the CBDT.
While a large number of start-ups/angel investors would still remain out of the exemption net due to lower threshold of INR 100 million, the challenges presently faced by the entrepreneur community would also continue to remain, as the notification would not apply where the assessments have already been concluded. Taking all these aspects into consideration, this notification would bring only limited relief.
It would also be interesting to see the approach that CBDT would adopt while granting approvals. It is expected that the valuations aspects are reviewed and questioned in a reasonable manner considering the huge potential in every start-up initiative.
It is also pertinent to note that the notification is only aimed at approval conditions specified in the earlier notification. The other requirements such as meeting the definition criteria, and recognition of the start-up still remain.
For further clarity on the Angel Tax issues, please refer to Spotlight segment of our newsletter ‘Tax Trends’.
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