Guidelines on the proposed angel tax

finance ministry will come out with the guidelines on the proposed angel tax next month to clarify how the tax will be levied and will also provide valuation guidelines. However, there will be no rethink on the Budget proposal to make the levy applicable to non-residents as well.

“Genuine startups registered with the department for promotion of industry and internal trade (DPIIT) will not be impacted. Valuation rules on how the investment will be calculated will also be issued. The objective is not to hurt genuine businesses but only ensure that those people who are trying to evade taxes come under the tax net,” said a person familiar with the development.

Valuation guidelines are necessary as the Income Tax Act and the Foreign Exchange Management Act value such investments using different methodologies.

Union Budget 2023-24 has proposed amendments in Section 56(2) VII B of the Income Tax Act and bring non-residents within its ambit to eliminate the possibility of tax avoidance.

At present, if an Indian unlisted company issues shares at a price exceeding its fair market value, it is liable to be taxed at a rate of 30%. Popularly known as the ‘angel tax’, it was initially introduced in 2012. Businesses incorporated before April 2016 can apply for exemptions from this section and Sebi-registered alternative investment funds (AIFs) are also exempt. About 80,000 startups registered with the DPIIT will be exempt.

The provision is now proposed to be extended to foreign investors as well, effective April 1, 2023, and has rattled startups who are concerned that it would impact fund-raising.

Sources indicated that while there will be no rethink on the proposal, the government will come out with clear rules through a notification clarifying the scope and intent of the tax proposal. “The rules are likely to be notified by April 15 once the Finance Bill is passed,” a source familiar with the development said, adding that it would clarify how and on whom the tax liability would fall.

Industry bodies and associations are understood to have also discussed the issue with the finance ministry and put forth their representations raising concerns that it could severely dent their ability to raise funds from foreign investors.

Tax experts have pointed out that startups could look at registering in other countries and foreign investors may also reconsider their investment strategies for the country and could look at operating through an AIF structure.

“The proposed changes may indeed have quite the contrary effect (and) drive away foreign investment from India. While we have witnessed several companies contemplating internalisation of their structures in the recent past, the suggested amendments to Section 56(2)(viib) may lead to a preference towards externalisation of structures to allow flexibility in deal structuring,” Nishith Desai Associates had said.

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