Budget 2019: Relief for Startups From ‘Angel Tax’ and IT Scrutiny

Finance Minister Nirmala Sitharaman on Friday, 5 June, proposed a series of steps to address the ‘angel tax’ woes of startups and provide relaxation from income tax scrutiny.

Noticing that startups are getting firmly rooted in India and encouraging their growth is important, Sitharaman announced many proposals to address ‘angel tax’, what is perceived by the startup community as its biggest bone of contention with the government.

“To resolve the so called angel tax issue, the startups and their investors who file requisite declaration and provide information in their returns will not be subjected to any kind of scrutiny in respect of valuations of share premiums,” she said.

An e-verification mechanism will be put in place to resolve the issue of establishing the identity of investors and the source of funds. She added, “With this, funds raised by startups will not require any kind of scrutiny from the income tax department.”

Also Read: Govt Eases Angel Tax Exemption, Expands Definition of ‘Start-Ups’

Startups Pleaded with PMO in January

‘Angel Tax’, the heart of startups’ discontent, under Section 56(2) (viib) of the Income Tax (I-T) Act, taxes any investments made by an Indian entity in an unlisted Indian company above fair market value as income.

A desperate plea by 68 startups, in a letter to Prime Minister Narendra Modi on 16 January, not only illustrated the distress caused by ‘angel tax’ but also served as an indictment of the government’s various startup initiatives.

"“Startups are in distress and many feel victimised mainly due to the subjectivity, cost and arbitrariness involved in the implementation of this anti-evasionary measure which treats every assessee as guilty until proven innocent.”" - Excerpt from a letter to the Prime Minister, which was signed by 68 startupsRelief From IT Enquiry

Sitharaman also said that special administrative arrangements will be made by the Central Board of Direct Taxes (CBDT) for pending assessment of startups and to redress their grievances.

“It will be ensured that no inquiry or verification in such cases be carried out by the assessing officer without obtaining approval of the supervisory officer. So the element of discretion with which startups were suffering has been removed,” she said.

The minister also announced that category two alternate investment funds (AIFs), who would be investing in startups would completely exempted from the ‘angel tax’. At present, startups are not required to justify fair market value of their share issue to certain investors, including category one AIFs.

“I propose to extend this benefit to category two AIFs also. Therefore, valuation of shares issued to these funds shall be beyond the scope of income tax scrutiny,” she said.

She also proposed to relax some conditions to carry forward and set-off losses in the case of startups.

“I also propose to relax some of the conditions for carry forward and set off of losses in the case of startups. I also propose to extend the period of exemption of capital gains arising from sale of residential house for investment in startups up to 31.3.2021 and relax certain conditions of this exemption.”

An angel investor puts funds in a startup when it is attempting to establish itself in the competitive market. Normally, about 300-400 startups get angel funding in a year. Their investment in a unit ranges between Rs 15 lakh to Rs 4 crore.

Building on Relaxations Announced in February

Providing major relief to budding entrepreneurs, the government in February relaxed the definition of startups and allowed them to avail full ‘angel tax’ concession on investments of up to Rs 25 crore.

After claims being made by several startups of receiving tax notices under Section 56 (2) (viib) of the Income Tax Act 1961, to pay taxes on angel funds received by them, the Department for Promotion of Industry and Internal Trade (DPIIT), in consultations with CBDT, resolved the issue.

Section 56 (2) (viib) of the I-T Act says that the amount raised by a startup in excess of its fair market value would be deemed as income from other sources and would be taxed at 30 percent.

Touted as an anti-abuse measure, this Section was introduced in 2012. It is dubbed ‘angel tax’ due to its impact on investments made by angel investors in startup ventures.

More than 540 startups have received exemption from ‘angel tax’ so far.

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