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Angel Tax, Meaning, Applicability and Exemption

Angel Tax regime is designed to address potential issues with inflated startup valuations but has been controversial due to its impact on new businesses seeking capital. Checkout about the angel tax regime in this article
authorImageShruti Dutta30 Jul, 2024
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Angel Tax

The Angel Tax, established in India in 2012, is a tax imposed on startups' funding received from angel investors. It is governed by Section 56(2)(viii) of the Income Tax Act, which states that if a privately held company issues shares to an investor at a price exceeding the fair market value, the excess is taxed as income. This tax aims to prevent money laundering and ensure the genuineness of investments.

However, the Angel Tax has sparked concerns within the startup community, as it can discourage investment in early-stage ventures critical for innovation and economic growth. Determining fair market value can be subjective and complex, adding to the difficulties for startups and investors. To address these issues, the government has introduced amendments and exemptions to reduce the tax burden on legitimate investments. These aim to create a more supportive environment for entrepreneurs while maintaining regulatory oversight.

What is Angel Tax?

Angel Tax is a tax imposed on investments made by angel investors in startups when the amount invested exceeds the fair market value of the company’s shares or securities. Specifically, if a startup receives funding that significantly exceeds the true value of its shares, the excess amount is subject to a tax rate of 30.9%. This measure prevents inflated valuations and ensures that investments reflect a fair market value. The tax applies to new and emerging businesses seeking capital from angel investors, typically high-net-worth individuals who invest early in startups. Startups must pay this tax to the Income Tax Department on the excess amount received, making Angel Tax an important consideration for investors and entrepreneurs navigating the funding landscape.

Which Investment Falls Under the Ambit of Angel Tax?

Angel Tax applies to investments made in startups under specific conditions. The types of investments that fall under the ambit of Angel Tax include:
  • Equity Investments : Investments made by angel investors in the form of equity shares in a startup.
  • Preference Shares : Investments in preference shares of a startup, which may also be subject to Angel Tax if the investment exceeds the fair market value.
  • Convertible Instruments : Investments through convertible debentures or convertible notes that convert into equity shares at a later stage.
  • Funding by High-Net-Worth Individuals (HNIs) : Investments made by individuals or entities considered high-net-worth, where the amount invested exceeds the startup's fair market value.
  • Investment Amounts Exceeding Fair Market Value : Investments that surpass the fair market value of the shares or instruments being issued by the startup.
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Angel Tax Exemption

Angel Tax is imposed at a significant rate of 30.9% on net investments that exceed the fair market value. For instance, if a startup receives an investment of Rs. 50 crores by issuing 1 lakh shares at Rs. 5000 each to an Indian investor, but the fair market value of the shares is only Rs. 2000 each (totalling Rs. 20 crores), the startup must pay Angel Tax on the amount that exceeds the fair market value, which is Rs. 30 crores. Consequently, the Angel Tax due for this transaction would be Rs. 9.27 crore (30.9% of Rs. 30 crore). In response to numerous appeals from startups, the Indian Government introduced some relaxations in the 2019 Union Budget. According to this budget, startups registered under the Department for Promotion of Industry and Internal Trade (DPIIT) are exempt from Angel Tax. To qualify for DPIIT registration and avoid Angel Tax, a startup must apply along with the required documents to the Central Board of Direct Taxes (CBDT). Upon approval by the CBDT, the startup will be exempted from paying Angel Tax. In addition to DPIIT registration, startups must meet several criteria to be eligible for the Angel Tax exemption. Here is a summary of these criteria:
  1. Capital and Share Premium Limits : The startup's maximum paid-up capital and share premium should not exceed Rs. 25 crore after issuing shares.
  2. Fair Market Value Assessment : As per Rule 11 UA (2)(b) of the Income Tax Act 1961, a merchant banker must evaluate the startup's fair market value.
  3. Exclusions from Calculation: Amounts raised from venture capital firms, NRIs, and other specified entities are excluded from the Angel Tax calculation. Additionally, the startup’s annual turnover should not exceed Rs. 100 crore in any preceding fiscal year.
  4. Angel Investor Eligibility : Angel investors can receive a 100% tax exemption on investments in startups if the average income of the investors does not exceed Rs. 25 lakh and their net worth is at least Rs. 2 crore over the past three fiscal years.
  5. Tax Holiday : Startups can benefit from a tax holiday for three consecutive years from the date of incorporation. During this period, they are exempt from paying taxes.

Angel Tax Rate in India

India's tax system is a blend of proportional and progressive taxation, varying based on income levels and other criteria. Among its various tax provisions, Angel Tax is imposed at a substantial rate of 30.9% on investments received by startups that exceed the fair market value of their shares or instruments. This tax applies to new businesses that secure funding from investors. The excess amount over the fair market value is subject to Angel Tax, which must be paid to the Income Tax Department. This measure ensures that investments that significantly exceed a startup's intrinsic value are taxed accordingly, reflecting the government's efforts to regulate and monitor equity inflows into new ventures.

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Angel Tax Rate, Investment and Exemption FAQs

Who pays Angel Tax?

Angel Tax is essentially the tax that unlisted companies (specifically startups) are liable to pay on the capital they raise through issuing shares.

What is the meaning of Angel Tax?

Angel Tax is a tax imposed on Indian startups receiving funding from investors above their fair market value. In 2019, exemptions were introduced under specific conditions. Budget 2024 abolishes the Angel Tax. Governmental efforts strive to strengthen the startup ecosystem.

Which startups in India are exempt from angel tax?

Startups having a paid-up capital of at most 25 crores and recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) are exempt from paying Angel Tax.
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