What is “Angel Tax” ?
The word Angel Tax got attention as the Tax Authorities in India (in this instance the “Income Tax Department”) began issuing notices to startups demanding tax on the amount of share premium (sharing more below on what this means) appearing in financial statements of startups pursuant to a fund raise. This happened more so where angel investors were investing early in the company’s journey and hence called “Angel Tax”.
What is “Share Premium”
Let’s take the following illustration
1. Startup is raising capital of INR 1,00,00,000 from Investors
2. Investors desire 16.67% equity in the company post their investment
3. Therefore the company issues 2,000 shares to the Investor in exchange for INR 1,00,00,000 to achieve the 16.67% investor equity holding
4. Hence Per Share price is INR 5,000 [i.e. INR 1,00,00,000/2,000]
5. Now, Company’s shares usually carry a certain face value (let’s say that’s INR 10 per share in our case)
6. Which means INR 4,990 is the value in excess of the face value of the share which is called “Share Premium”
7. It is this Share Premium of INR 4,990 per share (x) No of shares issued to the Investor that the Income Tax Department seeks to tax from the Startup
Phew ! That’s some quick math.
Why tax the premium
Well, the law on taxing share premium was brought in as an anti-abuse law as there were few entities that were taking advantage of this share premium not being taxed. In order to prevent this abuse a law was introduced requiring a company to justify the premium at which the shares were raised. If this was not justifiable then Tax Authorities would tax the share premium.
Who is subject to tax on the premium ? Angel Investor or Startup
It’s the startup that receives a notice to justify the share premium and if it’s unable to then Startup gets taxed on the Share Premium. Investors are not taxed here. Therefore there is no tax to be charged where startups are able to justify premium on the shares.
How to get Angel Tax Exemption ?
- Obtain DPIIT Recognition as an “Eligible Startup”
Read here on how to get this done : http://bjaa.in/insights/decoding-eligible-startups/
- Provide relevant self-declaration in Form-2
- Affix Director DSC and submit online on www.startupindia.gov.in
- Receive an email from Income Tax
An email about exemption from Section 56(2)(viib) of Income Tax Act (which is the section under which tax is levied but has been given exemption for the Startup)
- The Exemption is valid till aggregate amount of paid up share capital and share premium of Startup after issue or proposed issue of share, if any, does not exceed, twenty-five crore rupees (INR 25 Crores)
There are certain exemptions to computing this limit of INR 25 Crores which can be understood on a case to case basis.
Valuation Reports for justifying share premium ?
1. The Income Tax via Notification ascribed Merchant Bankers who could undertake valuation for companies that are issuing shares at premium.
2. Hence startups too would need to procure valuation reports from Merchant Bankers.
3. However where startups have the above angel tax exemption a position can be made that since the law is exempt to the Startup such a report would not be required.
Points to take care to ensure angel tax exemption is not revoked
Startup needs to take care of the following to ensure angel tax exemption is not revoked :
1. Valid DPIIT Recognition
2. No Investment investment funds in
(a) Building or land appurtenant thereto, being a residential house, other than that used by the startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
(b) Loans and advances, other than loans or advances extended in the ordinary course of business by the start-up where the lending of money is a substantial part of its business;
(c) Capital contribution made to any other entity;
(d) Shares and securities;
(e) A motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds INR 1 million, other than that held by the start-up for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
(f) Jewellery other than that held by the start-up as stock-in-trade in the ordinary course of business;
(g) Any other asset, whether in the nature of capital asset or otherwise, of the nature specified