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ANGEL TAX
BACKDROP AND
COMPREHENSIVE A N A L Y S I S
STEEP FALL IN ANGEL
FUNDING TO STARTUPS
The number of angel and seed funding deals halved to 435 in
2017 from 901 in 2016, according to a report. The total disclosed
value of these deals also fell sharply to $245 million from $374
million.
INDEX
1. Foreword
2. Overview
3. Background
4. What does the law says – Section 56 (2) (viib)
5. Challenge Faced by Government
6. Problems faced by Start-ups
7. Measures Already taken by the Government
8. Way forward
FOREWORD
This report is created to give comprehensive overview of
angel tax, and also problems faced by our nascent Startup
ecosystem as its consequences.
The Indian Startup eco-system will only thrive when new
ideas are nurtured at the very initial stage by providing right
funding and mentorship.
India needs to develop 1 million entrepreneurs for it to be
become economic super power, raising per capita income of
each one of our people.
More and more angel investment should happen from
domestic individual for the ecosystem to grow in real terms.
Simplifying rules around Angel funding will go way in
achieving that.
Alok Patnia
CEO and Managing Partner
Taxmantra Global
FOREWORD
Angel funding is the backbone of any emerging start-up
ecosystem. Entrepreneurs thrive on angel investments at the
right time and I have seen many a start-up idea die for want
of monetary support.
I hope the government will look at abolishing angel tax,
which will go a long way in helping entrepreneurs do what
they do best ie create and thrive.
Shradha Sharma
Founder and CEO at
YourStory.com
ANGEL TAXTAXMANTRA ANALYSIS
Overview
‘Angel Tax’ refers to section 56 (2) (viib) of the Indian Income
Tax Act, 1961, wherein the Income Tax Authorities are
demanding additional taxes from ‘Start-up Companies’ who
have received funding from Indian Resident ‘Angel
Investors’ at a valuation higher than what can be perceived
for an early stage start-up venture.
Background
‘Once Bitten, Twice Shy’ is a perfect proverb to define the
current mindset of the Income Tax Authorities, Central Board
of Direct Taxes (CBDT) and even the Ministry of Finance.
In the Income Tax Appellate Tribunal, Kolkata, Departmental
Representative, during a course of proceedings in the
Income Tax Appeal has explained the modus operandi of
conversion of black money into white through the medium
of shell companies.
He explained that the entire episode is completed through
three levels.
ANGEL TAXTAXMANTRA ANALYSIS
Background
In the first level, Company ‘A’ is incorporated on papers,
which does not carry out any substantial business activity.
Suppose, this company issues 10 shares to another dummy
company, say X with face value of Rs.1/ at a premium of
Rs.49, raising its share capital to Rs.500/-. The sum of
Rs.500/- standing on the liability side of the balance sheet
of company A is equalized with Investment in shares of
Company ‘B’, which is again a paper company, at a much
higher price than its real worth. Company ‘B’, in turn, gets
Rs.500/- and invests the same in the shares of another
dummy private limited company ‘C’, again at a huge
undeserving market price. This process goes on as the same
amount of Rs.500 is rotated through various dummy
companies eventually showing their capital and share
premium at Rs.500/- represented by investment in shares of
other dummy companies by equal amount of Rs.500/-
subject to the deduction of certain expenses incurred or
some petty income earned.
ANGEL TAXTAXMANTRA ANALYSIS
Background
In the second level, a person, say Mr. Y, intending to convert his
black money into white enters into a deal with company X, who is
shareholder of company ‘A’. Company X sells its shares of Company
A with the purchase price of Rs.500 at its real worth, say, Rs.6 per
share. Mr. Y purchasing shares of company A for apparent
consideration of Rs.6, pays Rs.494/- in cash and, thus, acquires all
the shares of Company ‘A’ with apparent investment of Rs.6/- and
real investment of Rs.500/-. Mr. Y retains these shares for a period
exceeding one year.
In the third level, the operators who have created this web of
dummy companies assist Mr. Y in selling the shares of company ‘A’
at Rs.500/- through fictious transactions entered into with Mr. Z.
Mr. Y realizes Rs.500/- in cash and brings this amount into
circulation. Profit of Rs.494/- [Rs.500(sales price) minus Rs.6
(apparent purchase price)] earned by Mr. Y is not chargeable to tax
in terms of section 10(38) as it arises `from the transfer of a long-
term capital asset, being an equity share in a company’. That is how,
Mr. Y converts Rs. 494/- from black to white.
ANGEL TAXTAXMANTRA ANALYSIS
The shares of company ‘A’ are sold through operators to Mr. Z,
who is interested in purchasing share loss. Mr. Z treats the
shares of company A either as his stock in trade or Investment,
depending upon his requirement. If these shares purchased
for an apparent consideration of Rs.500 are held by Mr. Z as
stock in trade, then at the end of the year, he will value such
stock in trade at market price, say at Rs.10. By doing so, he will
show a loss of Rs.490 from the valuation of shares, which will
be adjusted against his normal business income to this extent.
If Mr. Z treats these shares as Investment, then the operator
will help him in selling the shares at their market price of
Rs.10. Loss from the sale of Investment, being loss under the
head `Capital gain’, will be set off against any other capital
gain genuinely earned by Mr. Z. This is the entire mechanism
by which Mr. Y, who purchased the shares of Company A has
succeeded in converting his black money of Rs. 494 into
white. In the same manner, Mr. Y1 and Mr. Y2 etc. convert their
black money of Rs.494 into white by purchasing the shares of
Company B and Company C etc. The end result is achieved by
operators by routing the transactions of shares through
several layers of companies, thereby giving colour of
genuineness, which in reality is nothing but a camouflage
ANGEL TAXTAXMANTRA ANALYSIS
CHALLENGES FACED BY THE
GOVERNMENT
Challenges faced by Government
With conjunction of black money hoarders, finance
professional and government officials, a practice was
developed wherein, closely held companies could bring in
undisclosed money of promoters/directors or even third
parties (For a commission) by issuing shares at high
premium which is normally over and above the book value
of share of the company.
Moreover in case of many closely held companies and even
in new companies promoters used to issue share at
premium with the main purpose of keeping share capital
low, yet capital base stronger so that breakup value and
market value is high. This leads to advantage of low cost of
servicing share capital and also improved prospects to issue
share at premium in future by way of initial issue of offering
by promoters. One more practical advantage was to save
on account of cost of fees payable on increase of
authorized capital.
ANGEL TAXTAXMANTRA ANALYSIS
Challenges faced by Government
When shares are issued at premium, number of shares and
authorized capital increase lesser in comparison of capital
raised by way of capital and premium. These provisions are
deeming provisions as otherwise share premium and
capital is a capital receipt which cannot be taxed as income.
“As per a media report A little over 11,281 Companies are
registered at 148 addresses, an average of 76 each. Seven of the
top 10 most common addresses were found in Kolkata. Income
Tax Department started investigations and crackdown on such
shell companies.”
It is this network of shell companies and this shabby but
remunerative business of conversion of black money to
white, the then Finance Minister of India, Mr. Pranab
Mukherjee, in Budget 2012 effective from Assessment Year
(AY) 2013-14, introduced section 56 (2) (viib), which is now
also termed as ‘Angel Tax’.
ANGEL TAXTAXMANTRA ANALYSIS
ANGEL TAXTAXMANTRA ANALYSIS
WHAT DOES THE LAW SAY
SECTION 56 (2) (Viib)
Section 56 (2) (viib)
Clause (viib) of sub section (2) of section 56 was inserted
vide finance act, 2013 w.e.f 01.04.2013 i.e. for A. Y. 2013-14
to provide that where a closely held company issues its
shares at a price which is more than its fair market value
then the amount received in excess of fair market value of
shares will be charged to tax in the hand of the company as
income from other sources.
Clause (viib) is read as under:-
“Where a company, not being a company in which the public
are substantially interested, receives, in any previous year,
from any person being a resident, any consideration for issue
of shares that exceeds the face value of such shares, the
aggregate consideration received for such shares as exceeds
the fair market value of the shares:
ANGEL TAXTAXMANTRA ANALYSIS
Section 56 (2) (viib)
Provided that this clause shall not apply where the
consideration for issue of shares is received—
(i) by a venture capital undertaking from a venture capital
company or a venture capital fund; or
(ii) by a company from a class or classes of persons as may
be notified by the Central Government in this behalf.
Explanation.—For the purposes of this clause,
(a) the fair market value of the shares shall be the value—
(i) as may be determined in accordance with such method as
may be prescribed; or
(ii) as may be substantiated by the company to the
satisfaction of the Assessing Officer, based on the value, on
the date of issue of shares, of its assets, including intangible
assets being goodwill, know-how, patents, copyrights,
trademarks, licences, franchises or any other business or
commercial rights of similar nature,
whichever is higher;
ANGEL TAXTAXMANTRA ANALYSIS
Section 56 (2) (viib)
(b) “venture capital company”, “venture capital fund” and
“venture capital undertaking” shall have the meanings
respectively assigned to them in
clause (a), clause (b) and clause (c) of Explanation to clause
(23FB) of section 10];”
The law clearly says that in case of equity or preferential
investments in a Company, anything over and above the
Fair Market Value (FMV) of the Shares shall be taxable as
‘Income From other sources’ for the Company. Also, the
FMV shall be the higher of the valuation as per prescribed
rule 11UA or ‘to the satisfaction of the Assessing Officer
(AO)’.
Rule 11UA talks about the computation of book value of
the shares as computed by the defined formula or as per
Discounted Cash Flows (DCF), certified by a CA or merchant
banker.
ANGEL TAXTAXMANTRA ANALYSIS
ANGEL TAXTAXMANTRA ANALYSIS
PROBLEMS FACED BY STARTUPS
AND ANGEL INVESTORS
Problems faced by Startups and Angel Investors
Ideally, if FMV as determined based on future projections
and Discounted Cash Flows (DCF) and certified by a CA or a
merchant banker, even if higher than the actual book value
or even what has been construed by the Assessing Officer,
should stand good and 56 (2) (viib) invoked, only if
investment is at a valuation higher than the DCF valuation.
However, the main controversy is in the concept of 'fair
value'. Investors value a company based on its potential and
future capacity vouching on its founders and team,overall
idea, scale, footprint, GMV, growth rate, revenue and run
rate.
However, problem arises when the performance of the
company doesn't match its initial projections and the IT
department due to the benefit of hindsight invalidates the
original valuation, thereby, reducing its 'fair value' at the
time of assessment and increasing the premium amount on
which the tax is to be levied.
ANGEL TAXTAXMANTRA ANALYSIS
Problems faced by Startups and Angel Investors
Startups work on certain presumptions and each valuation
is done after rounds of negotiations, valuation reports,
bankers report and several other regulatory compliance
between the company's promoters and the investors. In
fact, there can be circumstances that the company is
struggling to stay afloat and its valuation would have
decreased anyways.
But that doesn't invalidate its original projections. There are
several reports that suggest that almost 80% of startups fail
within the first five years. Several founders and investors
have been questioning the rationale of the IT department
on asking startups to pay tax on the amount they raise 2-3
years back irrespective of whether they made profits or not.
Taxing profit on the capital invested by investors, or the
profits of the company is fair but taxing the capital raised
doesn't seem logical. "Whether it is share capital or share
premium that is raised by the company, it is still capital
received. It should not be treated as ‘revenue income’." The
problem further aggravates as the IT department is not just
ANGEL TAXTAXMANTRA ANALYSIS
asking for 30.9% tax, but the interest and then also raising
demands for penalty for non-payment of tax, killing all the
motivation of starting up and generating employment for
the Country. Words like ‘Start-up India’, ‘Make in India’ and
‘Digital India’, seem to be jokes with such Draconian law.
The rationale of this law was to address the issue of money
laundering wherein people were taking up shares at a
premium for very little equity and using this mechanism to
convert black money to white. But the big question remains
that can all investors be brushed in the same colour due to
a handful of black sheep?
The underlying problem seems to be the problem in
revenue recognition policy of the Income Tax department.
The IT officials have targets to meet for the revenue
collection, just like sales people in companies. On top of
that, if they book the company by sending them a demand
notice, the specified amount becomes a part of their
revenue and its an easy way to meet their targets.
ANGEL TAXTAXMANTRA ANALYSIS
ANGEL TAXTAXMANTRA ANALYSIS
MEASURES ALREADY TAKEN BY
GOVERNMENT
Measures Taken by Government
Start-up India Initiative
The Startup India Initiative currently provides the following
benefits to a startup:
1. Tax exemptions on income tax for three years
2. Tax exemption on capital gains and on investments
above fair market value (angel tax)
3. Self-certification and compliance under nine
environmental and labour laws
4. Startup patent application fast track, and up to 80
percent rebate in filing patent
5. Rs 10,000 crore fund of funds for investment in startups
through SEBI registered Alternate Investment Funds (AIF)
6. Rs 2,000 crore credit guarantee fund
7. Winding up company in 90 days under Insolvency and
Bankruptcy Code 2016
8. Public procurement in all central government ministries’
departments
ANGEL TAXTAXMANTRA ANALYSIS
Start-up India Initiative
However, it has not benefited startups at large.
As per the Startup India status report dated October 20,
2017, available at the Startup India website of the
Government of India:
74 startups were approved by the Inter-Ministerial
Board to avail tax benefits.
Of the Rs 10,000 crore fund of funds, Rs 600 crore has
been released to SIDBI with a total commitment of Rs
605.7 crore to 17 AIFs. A total of 75 startups have been
funded through AIFs.
Approvals from DIPP, and then from IMB, are turning out to
be a time taking process, and created blockades. The
approval should be more system-driven and automatic.
Also, blanket tax benefits (as available for startups in
Singapore) should be the way forward.
The requirement barrier created in the definition of a
startup creates scope for judgement and red-tapism.
ANGEL TAXTAXMANTRA ANALYSIS
Amendment in the Union Budget 2018
The provisions under section 80-IAC provides deduction to
eligible start-up with respect to profits and gains derived
from eligible business upto 100% for three consecutive
assessment years out of five years at the option of assesse
in accordance with and subject to provisions of said section.
A comparative study of the criteria to be fulfilled under
present scenario and the changes proposed in Budget-
2018 is presented below:
ANGEL TAXTAXMANTRA ANALYSIS
Amendment in the Union Budget 2018
ANGEL TAXTAXMANTRA ANALYSIS
Present Scenario Proposed Changes in Budget-2018
(i) In order to avail the benefits of section
80-IAC, the start-up should have been
incorporated on or after 1st April 2016
and before 1st April 2019.
The benefits has been extended to the
start-ups incorporated even after 1st April
2019 and before 1st April 2021.
(ii) The turnover of the business should
not have exceeded Rs 25 crore rupees in
any of the previous years from 1st April,
2016 to 31st March, 2021.
The requirement of turnover of Rs 25
crore rupees has been applied to seven
previous years commencing from the
date of incorporation.
(iii) The word eligible business includes
innovation, development, deployment or
commercialization of new products,
processes or services driven by
technology or intellectual property.
The definition of eligible business has
been expanded to the business engaged
in innovation, development or
improvement of products or processes or
services, or a scalable business model
with a high potential of employment
generation or wealth creation.
As the amendment will come into effect from 1st April 2018, it will surely
impact the major start-ups who are involved in business of innovation and
development of products and shall benefit the start-ups commencing their
businesses even after 1st April 2019. As the definition of startups have been
eased out to a further extent, the start-ups who are able to get the Start-up India
registration shall also save themselves from the ‘Angel Tax’
No Angel Tax on Start-ups with up to 10 Cr Funding
As per certain media reports, The Department of Industrial
Policy and Promotion (DIPP), is working on an amendment
and shall notify the same, wherein, the start-ups
incorporated prior to 2016 (Currently Income Tax benefits
are available only to start-ups incorporated after 2016 and
who have obtained approval from DIPP and Inter Ministerial
Board) and have raised funding of up to Rs. 10 Cr, shall be
exempted from the ‘Angel Tax’.
However, the official notification is still awaited.
ANGEL TAXTAXMANTRA ANALYSIS
Circular from Central Board of Direct Taxes (CBDT)
The CBDT has directed the taxman not to undertake “coercive”
steps in recovering pending taxes from startups under a specific
provision of the Income Tax Act, a move aimed to help budding
entrepreneurs in the country. The move assumes significance as
startups in the recent past had flagged their grievances to the
government regarding ‘angel tax’ provision, which, they
considered, was not friendly to them. The Central Board of Direct
Taxes (CBDT), in a circular to all the field offices of the department,
said it has come to its notice that in recent times, a specific
provision (determining of fair market value of shares) of the I-T Act
is being invoked in the case of startups, which had otherwise raised
a genuine investment on the basis of their idea. “In view of this no
coercive measure to recover the outstanding demand would be
taken,” it told the assessing officer (AO).
The board directed the taxman to take necessary steps for
“expeditious” disposal of appeals of such firms pending before the
first appellate forum of the officer of the Commissioner (Appeals),
by March 31 this year. The directive would help startups in
effectively tackling the issue of ‘angel tax’ — the taxing of
investments made by ‘angel’ investors in such newly raised and
innovative idea-based companies.
ANGEL TAXTAXMANTRA ANALYSIS
ANGEL TAXTAXMANTRA ANALYSIS
TAXMANTRA’S TAKE AND THE
WAY FORWARD
Way Forward
Ensuring fair assessment
A better way would be for senior members of the department to
lay down detailed parameters for fair assessments, before making
such additions to income, and to check the genuineness of the
transaction. Only then should the claim in the notices be allowed
to be accounted as revenue, and not merely by raising a demand
notice. Otherwise we will not only discourage entrepreneurs but
will also add on to an already long queue of tax litigation. Laws
such as these especially for fledgling companies will put India on a
back foot and kill the motivation in entrepreneurs to start-up in the
country.
The government is moving in the right direction by moving toward
e-assessment with no human intervention in the whole process of
communication. However, practical difficulties are not allowing this
process to thrive. The Income Tax portal will have to be smarter
and more user friendly to take this to the next level.
Also, the discretionary powers of the Assessing Officer will have to
be taken away and process driven approach to assessment should
be taken up.
ANGEL TAXTAXMANTRA ANALYSIS
Way Forward
Simple Registration of Angel Investors
In any economy and ecosystem, the role of domestic and
traditional businessmen and investors cannot be undermined. In
the nascent stage of the Indian Start-up econ-system many old and
renowned business houses and High Net-Worth Individuals turned
into Angel Investors, mostly in Individual capacity. However, with
lack of clarity on taxation front and lot of notices flowing from the
Income Tax Department, not only to start-ups but also to Angel
Investors have made the Angel investors skeptical to Investing in
Start-ups in India.
The right way perhaps should be to ask angel investors to register
in the Income tax portal with Tax residency certificate or PAN Card
number and other details. The existing registration as an Alternate
Investment Fund (AIF) or a Venture Capital (VC) firm is a very long
and expensive process. It takes atleast 3-4 months and involves
government fee itself in lakhs of rupees and it also several
approvals from different regulatory authorities, making this non-
viable for angel investors to get this registrations.
ANGEL TAXTAXMANTRA ANALYSIS
Way Forward
Simpler and more process driven Start-up India
Registration
Again, the discretionary powers of DIPP or IMB for granting
Start-up India registration for income tax benefits should
be more automated and process driven rather then giving
discretionary powers to the officers to determine if the
start-up is innovative or not or whether it would generate
enough employment or not.
The Government is doing its bit and the Country and the
Start-up ecosystem has come a long way in last few years.
However, a lot still has to be done and creating the
conducive environment for both budding entrepreneurs
and domestic investors is very important.
ANGEL TAXTAXMANTRA ANALYSIS
Taxmantra is a global legal, taxation, compliance and
due-diligence firm with presence in India, Singapore, US
and Middle East.
Since inception in 1983, 40K+ customers have hired
Taxmantra Global as a trusted partner to manage their
compliance, due-diligence, fund raising, taxation and
corporate law.
Several startups, technology companies and SMEs
trust Taxmantra as their Cloud CFO.
• $100M funding assisted
• 300K+ compliances filed
• 3 decades of experience
• Trusted by startups, new
age tech businesses and
investors
TAXMANTRA GLOBALINTRODUCTION/ ABOUT
TAXMANTRA SERVICES
BUSINESS STAGE: EARLY/ STARTING UP
Entity Formation
Local State Specific Compliances, Taxation & Registration
Corporate Law (agreements)
ESOPs Structuring
Trademarks, Patents Filing & Copyrights
Cloud CFO
BUSINESS STAGE: GROWTH STAGE
Taxation
Corporate Law (Litigation Assistance)
Regulatory Compliances
Due-Diligence/ Fund-Raise Assistance
ESOPs Structuring
Cloud CFO
BUSINESS STAGE: MATURE
Taxation
Corporate Law (Litigation Assistance)
Regulatory Compliances
Due-Diligence/ Fund-Raise Assistance
IPO Readiness & Listing On SME Exchange
Cloud CFO
TAXMANTRA ADVANTAGE
DIALOGUE
TAD is a thought leadership platform established by
Taxmantra to share global best practices and unlock more
growth opportunities for Taxmantra customers globally.
We host highly focused workshops and conferences that
share highly valuable content for business owners/
entrepreneurs.
TAD features global speakers on various subjects
pertaining to taxation and law for startups, new age
businesses and technology companies.
LEADERSHIP TEAM
ALOK PATNIA
CEO & Managing Partner
Taxmantra Global
Alok is the CEO and Managing
Parter at Taxmantra Global
Network Firms. He is a Fellow
Member of the ICAI (FCA ), an
alumnus of St. Xavier’s College,
Calcutta, with post qualification
exposure in KPMG and Ernst &
Young.
He has authored more than 2K
blogs on Taxmantra.com and
also contributes to leading
platforms like YourStory.com,
Moneycontrol.com.
Rahul serves as VP Operations at
TaxMantra Global. He is a Fellow
Member of the ICAI (FCA), and holds a
Diploma in Information Systems Audit
from the Institute of Chartered
Accountants of India, having 10 years
of experience in handling income tax
Search Seizure and Survey
assessments, Appeals, Regular
Assessments and other litigation and
departmental proceedings relating to
Income Tax Act, Service Tax, VAT and
International Taxation. He is into
Advisory, Litigation and Compliance
relating to Direct Taxes, Indirect Taxes,
Corporate Law and various Labour
Laws in India.
RAHUL AGARWALLA
VP Operations- India
(South) Taxmantra Global
LEADERSHIP TEAM
Kenneth Ho
VP Operations
TaxMantra Global
(Singapore)
CA RK Patnia
Non Executive Chairman
Taxmantra Global
Kenneth Ho currently serves as VP
Operations (Singapore) as Taxmantra
Global. Kenneth is a professional
trained Accountant with more than
10 years of experience gained from
his employment with 2 mid-tier
international accounting firms and 2
global outsourcing firms. Not limiting
his exposure to accounting
compliance, his experience includes
corporate secretarial compliance,
personal & corporate tax compliance,
Goods & Services Tax (GST)
compliance & payroll compliance
services too.
CA RK Patnia serves as non-
executive chairman at Taxmantra
Global. He is the past president of
Income Tax Bar Association and also
past chairman of The Institute of
Chartered Accountants of India
(ICAI).
He has vast experience in the field of
tax and advisory and known for his
technical expertise in the handling of
income tax search and raid
assessment especially, in active
practice since the year 1983.
LEADERSHIP TEAM
Paritosh serves as the Consulting
VP, Growth & Strategy with
Taxmantra Global.
Paritosh is a leader in brand,,
marketing and business
communication. He has helped
SMEs globally engage powerfully
with new media.
He is also the author of world's first
business book on Patanjali.
PARITOSH SHARMA
Consulting VP - Growth
Taxmantra Global
+91 983603903
fb . com/taxmantra
@taxmantra
www.taxmantra.com
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