Investors and the startup community in India are excitedly awaiting the first Union Budget of Modi 3.0, with high expectations for the repeal of the divisive angel tax scheme. This opinion is the result of years of insufficient relief policies that haven’t succeeded in considerably reducing the compliance load on new businesses. The Finance Ministry has the final say, but the Commerce Ministry has suggested eliminating the angel tax—a move that the startup sector has long called for.
Background of the Angel Tax Regime
Introduced in 2012 as an anti-abuse measure to curb money laundering, the angel tax regime has been a contentious issue for startups. The tax is levied when a startup raises funds at a valuation higher than the fair market value of its shares, as determined by a merchant banker. The premium paid by investors is treated as income and taxed at approximately 31%. This provision has led to significant compliance challenges, even for genuine investments, prompting repeated calls for its removal.
Partial Concessions and Ongoing Challenges
In response to the outcry from startups and investors, the government made some concessions in 2019. Startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT) were exempted from the angel tax, but this exemption was not blanket and required certification from the Inter-Ministerial Board (IMB). Despite these measures, the compliance landscape remained complicated, and the relief was insufficient for many startups.
The Finance Bill of 2023 added to the concerns by removing the exemption for investments made by foreign investors, though investments by SEBI-registered alternative investment funds continued to be exempt. This change heightened apprehensions about the attractiveness of the Indian startup ecosystem to foreign investors.
The Case for Eliminating the Angel Tax
The CEO and founder of Moglix, Rahul Garg, highlighted the possible advantages of doing away with the angel tax. The $7 billion in capital that was just raised in H1 2024 shows encouraging development potential. “The removal of the Angel Tax on startups would be a welcome step to further accelerate this momentum, as it can increase domestic capital formation and ease of doing business,” he stated.
Garg’s remarks reflect a more general feeling among entrepreneurs that doing away with the angel tax may greatly increase funding and industry expansion. The angel tax has received a lot of flak for putting up needless obstacles and turning off possible investors.
Commerce Ministry’s Recommendation
The Finance Ministry will make the final decision, according to DPIIT Secretary Rajesh Kumar Singh, who addressed the media earlier this month. “The decision is to be taken by the Ministry of Finance; we have provided our inputs. It was not raised during the pre-budget consultations,” Singh said on July 4. However, Singh’s recommendation is in line with the long-standing demand from the startup community, which has argued that the tax is counterproductive to fostering innovation and entrepreneurship in the country.
Potential Impact on the Startup Ecosystem
Eliminating the angel tax could have far-reaching implications for the Indian startup ecosystem. It could simplify the funding process, attract more domestic and international investors, and ultimately foster a more conducive environment for startups to thrive. The ongoing growth and success of startups are crucial for job creation, economic development, and technological advancement in India.
The startup sector has already shown resilience and growth potential, as evidenced by the substantial funding raised in the first half of 2024. Removing the angel tax could further accelerate this momentum, positioning India as a more attractive destination for startup investments.
As the startup community eagerly awaits the upcoming Union Budget, the potential removal of the angel tax remains a key focus. The final decision by the Finance Ministry will be pivotal in shaping the future landscape of startup investments in India.
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