End of the Angel Tax in India: Applicable for FY 2025-26

India has emerged as a global leader in entrepreneurship, housing the world’s third-largest pool of unicorn startups. This remarkable growth has been fueled by government policies and an ecosystem conducive to innovation. However, the entrepreneurial journey in India has not been without its challenges. A significant roadblock has been the contentious “angel tax,” a provision that dampened investment inflows and created financial strain for startups. In a landmark announcement during the Union Budget 2024, the Indian government declared the abolition of this tax for all categories of investors, effective from the financial year (FY) 2025-26.

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This reform is a turning point for startups and investors alike. By removing this bottleneck, the central government aims to stimulate innovation, attract more foreign capital, and provide startups with the financial freedom to scale operations. Let us delve into the origins of the angel tax, its implications, and how its abolition will transform India’s entrepreneurial landscape.

Understanding the angel tax

Introduced through the Finance Act 2012 under Section 56(2)(viib) of the Income Tax Act, 1961, the angel tax aimed to address money laundering concerns by taxing excess premiums received by unlisted companies. Specifically, if a startup issued shares at a price exceeding its fair market value (FMV), the excess was deemed “income from other sources” and taxed at a steep 30.9 percent rate.

The intent behind the angel tax was to prevent unaccounted money from being funneled into private companies. However, it inadvertently created significant hurdles for legitimate startups, especially those dependent on high-value investments from domestic and foreign investors.

Illustrative example

Consider a startup receiving an investment of INR 150 million (US$1.7 million) against a fair market value of INR 100 million (US$1.18 million). The excess INR 50 million (US$590,541) would be taxed at 30.9 percent, resulting in a liability of approximately INR 15.5 million (US$183,067). This additional burden discouraged investments and stifled growth, particularly during a startup’s critical formative years.

The challenges created by India’s angel tax

Over the past decade, the angel tax provisions have been fraught with controversies and implementation challenges. Startups faced significant hurdles due to ambiguities in valuation methodologies and inconsistent tax administration. Key challenges included:

1. Valuation disputes: Tax authorities frequently rejected valuations provided by startups, often recalculating them using unclear or subjective methods. This led to protracted disputes and financial uncertainties.
2. Conflict with FDI regulations: The valuation methods mandated under angel tax provisions often contradicted those specified under Foreign Direct Investment (FDI) norms, creating confusion for startups and investors.
3. Applicability in special cases: The tax was imposed even in cases like distressed funding, bonus issues, or conversions of convertible instruments into equity shares, deterring investors during critical financial junctures.
4. Barriers for foreign investors: In 2023, the tax was extended to include investments from non-resident shareholders, further complicating matters and making India less attractive to global investors.

These issues not only hindered the ability of startups to secure funding but also created a perception of regulatory unpredictability, deterring foreign investors from participating in India’s startup boom.

Key milestones leading to the abolition

While the government made intermittent attempts to address the challenges posed by the angel tax, these measures fell short of resolving the underlying issues.

1. 2016 DPIIT exemptions: Startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT) were exempted from angel tax. However, stringent eligibility criteria limited the effectiveness of this measure.
2. 2019 relaxations: The government further eased rules, allowing DPIIT-registered startups to secure exemptions. Startups needed to file declarations and adhere to strict thresholds for paid-up capital and turnover to qualify.
3. 2023 extension to non-resident investors: Despite the intent to broaden the scope of angel tax, extending it to non-residents created additional complications, amplifying the call for its abolition.

Recognizing the ongoing challenges and growing criticism, the government took the bold step in the Union Budget 2024 to abolish the angel tax for all categories of investors, effective FY 2025-26.

Implications of the abolition of India’s angel tax regime

The decision to abolish the angel tax is expected to have far-reaching implications for India’s startup ecosystem and its attractiveness as an investment destination per industry watchers.

1. Boosting foreign investment

The abolition removes a critical barrier for foreign investors, making it easier to participate in India’s burgeoning startup ecosystem. Simplified tax structures and reduced compliance risks will likely attract more global capital, fostering innovation and growth.

2. Enhancing startup valuations

Without the constraints of angel tax, startups can focus on presenting accurate valuations aligned with market conditions rather than catering to arbitrary regulatory standards. This alignment with global practices will enhance investor confidence.

3. Reducing litigation and uncertainty

The contentious nature of the angel tax has resulted in numerous legal disputes over the years. With its abolition, startups can avoid protracted litigation and instead channel their energy toward scaling operations and innovation.

4. Aligning with global standards

The move positions India as a competitive destination for startups and investors, aligning its policies with those of global startup hubs. This is particularly significant for fostering cross-border collaborations and partnerships.

Unresolved issues and the road ahead

While the abolition of angel tax is a significant milestone, certain unresolved issues require attention to fully realize its potential benefits:

1. Pending litigation: Startups with ongoing disputes under the previous provisions need a clear resolution framework to avoid prolonged uncertainty.
2. Clarifications on related amendments: The absence of changes to the definition of “income” under Section 2(24)(xvi) creates ambiguity, necessitating further legislative clarification.
3. Holistic Support for Startups: Beyond tax reforms, measures such as access to credit, simplified compliance processes, and infrastructure support are crucial for nurturing a vibrant startup ecosystem.

An opportunity for foreign investors

For foreign investors, the abolition of angel tax represents a golden opportunity to tap into India’s dynamic startup landscape. Key benefits include:

• Increased returns on investment: With startups retaining more capital, investors can expect improved returns and scalability.
• Regulatory certainty: Simplified regulations ensure a more predictable investment environment.
• Access to a thriving ecosystem: India’s startup ecosystem is a hotbed of innovation, offering diverse opportunities across sectors like technology, healthcare, fintech, and renewable energy.

Conclusion

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The abolition of the angel tax for all categories of investors marks a watershed moment for India’s entrepreneurial journey. By removing a significant financial and regulatory burden, the Indian government has demonstrated its commitment to fostering innovation and attracting global investments.

For startups, this reform translates into greater financial freedom, reduced litigation, and an enhanced ability to compete on a global stage. For investors, it opens the door to untapped opportunities in one of the world’s most dynamic startup ecosystems. With effective implementation and resolution of pending issues, this move has the potential to catalyze India’s vision of becoming a global innovation hub.

As India ushers in this new era of growth and collaboration, foreign investors are well-positioned to play a pivotal role in shaping the future of its startup ecosystem.

(US$1 = INR 84.67)

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