With a view to boost up the Startup eco-system and transform the nation into hub of startups, Indian government had initiated various schemes and programs (e.g., Startup India, Make in India, etc.).

This is one side of the coin.

On the other side, 30% tax levied on investments made by external investors in startups is considered (‘Angel Tax’) imposed by the government is the cause for concern as it will likely to sidestep and outweigh the benefits conferred on the startups under those schemes.

This Angel Tax is not imposed on the entire investment –any investment that exceeds “Fair Market Value (FMV)” valuations of the startup will be subject to Angel Tax commutation and classified as ‘income from other sources’ in the Income Tax Act of India.

The criticality lies at the core prospect of fair valuation process as the substantial valuation of startups is based on discounted cash flows, without taking into account intangibles like goodwill.

As a consequence, different interpretations of “fair value” may be employed and expose startups to high taxes owing to the high investment causing over valuation and defeating the very objective of startups oriented schemes.

As a consequence of imposition of ‘Angel Tax’ unlisted companies may be forced to face potential tax implications upon the occurrence of following transactions:

·    Tax on the shares acquired (below FMV) by the shareholder should be paid as normal income on the difference between purchase value and FMV.

·    Tax on the shares sold (above FMV) by the firm should be paid on the difference between the allotment price and FMV.

Investment in the eligible startups (registered with the Department of Industrial Policy and Promotion [DIPP]) are exempted from the Angel Tax provided such entities fulfill the requisite eligibility parameters as provided in the startup definition.

A startup is eligible for exemption (from the ambit of Angel Tax) only for the first seven years from its incorporation provided the objective of startup establishment is related to innovation, development or improvement of products or processes or if it is a scalable business model with a high potential of employment generation or wealth creation.

Another proposal (exemption of startups incorporated prior to 2016 with investment of INR 10 crore via angel funding from Angel Tax ambit) is under deliberation.

Unfortunately, certain cross functional provisions are sending-off the startup fraternity into dilemma and de-stressing state of affairs.

One provision is that in order to be treated as a startup any entity turnover should not exceed INR 25 crores – another provision (startups business objective should be innovative and business scale-able) that is contrary to the earlier provision.

From these provisions it is evident that there are certain gaps within the schemes articulated by the government defeating the very objective of the startup schemes.

It is high time for the government to pay immediate attention towards cross functional provisions and amend such provisions to ensure all the provisions under the startup oriented schemes should be supplemental to each other and not contradictory.

To endure the government labors to sustenance startup ecosystem, it is important to revisit certain tax provisions related to startups and to modify them in line with the aspirations of the government and startup fraternity – ultimately to achieve the objective of transforming the nation into hub of startups and innovative companies.

Research inputs by Paruchuri Baswanth Mohan