I-T dept’s angel tax notice snips at Indian start-ups’ flight forward
At least five out of 10 start-ups in the city have been served income tax notices pertaining to angel tax, that is proving to be a spanner in the works of their progress. Although the Central Board of Direct Taxes (CBDT) had recently clarified asking taxmen to refrain from “coercive measures,” stakeholders are wilting under pressure with the notices playing havoc with the start-up ecosystem.
By : migrator
Update: 2019-01-02 11:51 GMT
Chennai
Vikram Gupta, Founder, IvyCap Ventures, termed the issuance of notifications to several of its portfolio companies, as arm-twisting tactics of taxmen to settle via payments. “The tax authorities need to do their homework, before sending notices to companies,” he said, highlighting the fact that many of the firms included VC-funded entities, which were tax exempted. Some of them had been registered with the Department of Industrial Policy and Promotion (DIPP) and serving notices arbitrarily only upsets start-ups and the investing community. “If they suspect the system is being misused, they can approach the Registrar of Companies (ROC), and scrutinise the firms concerned,” Gupta said, noting that such moves were coming at a time, when the debate about angel tax is still to be resolved.
According to R Kannan, Partner, RKRV Associates, and Charter Member of TiE Chennai and Chennai Angels. “Individual investors that are part of Chennai Angels, who fund start-ups are accredited, accomplished investors, who invest in a lot of companies and know their valuation.”
As per information available with Kannan, out of 10 companies, at least five companies would been served notices. Interestingly, there have been positive rulings too with the assessing officers paying heed to the explanations offered by the representatives of the stakeholders. “We have obtained favourable rulings as well since we were able to explain our stance. Beneficiaries include companies working in the biotech, greentech and fintech spaces, backed by Chennai Angels,” he added.
The reasoning provided to the assessing officers is the need to overlook the premium aspect, given that it is only a derivative. “It is the valuation which is vital. The intention between the investor and the entrepreneur is to get a 20 or 30 per cent stake, which depends on valuation. This is important as the premium is irrelevant,” Kannan said.
Elaborating on the same, he cites an example of premium which is based on investments: “We try explaining to the assessing officers that premium is only a function of the valuation. What needs to be seen is the generation of revenue over a period of four to five years. When projections in the initial years do not match the actuals, the taxmen tend to question the mode of valuation. They feel that the discounted cash flow model is flawed. Our reasoning is that projections are made based on the conditions prevalent on that date. Probably, next year the situation may worsen, or market conditions may change. What is projected may not meet the actual as there could be a deviation,” Kannan pointed out.
“Even for many public sector companies, when premiums are fixed, based on valuation, there may be cases when the actual outcome does not meet the projection. We need to explain such technicalities also to the taxman,” he noted.
The amendment to the angel tax was brought in to curb money laundering activities and the conversion of black money into legitimate sources of income. “But when you know the regular investors, whose credentials are available and their source of income is genuine, such a questioning is unwarranted,” the charter member said.
What is ANGEL TAX
- An angel investor is the one who funds a startup when it is taking baby steps to establish itself in the competitive market. Normally, about 300-400 startups get angel funding in a year.
- Several startups have raised concerns on taxation of angel funds under Section 56 of the Income Tax Act, which provides for taxation of funds received by an entity.
- It said that the department in consultation with the revenue department has put in place a mechanism since April to grant exemption from the provisions of Section 56 (2) (viib) of the Income Tax Act to genuine investors in recognised startups.
- Earlier in April, the government gave relief to startups by allowing them to avail tax concession if total investment, including funding from angel investors, does not exceed Rs 10 crore.
- As per a notification by the commerce and industry ministry, an angel investor picking up stakes in a startup should have a minimum net worth of Rs 2 crore or should have an average returned income of over Rs 25 lakh in the preceding three financial years.
- Section 56 of the IT Act provides that where a closely held company issues its shares at a price more than its fair market value, the amount received in excess of the fair market value will be charged to tax the company as income from other sources.
Not a positive framework for innovation
Senthil Natarajan, Co-Founder-CEO, OpenTap says, “We haven’t been impacted by angel tax directly. This means only one thing - we haven’t been served a notice by IT Dept as of now. But we have raised money from angel investors and the I-T department can potentially query us which is always in the back of our mind. No matter what established procedures a start-up uses to raise funds, once a query is raised it’s the responsibility of a fledgling startup to prove that the “valuation” of an idea which is what a start-up is, is accurate and fair. And if considered high, the tax is 30.9%. This doesn’t add to a positive milieu for innovation. Here lies a major conundrum - in start-up valuations or even direct benefits aimed to help the common man – blatant corruption exists. Angel tax was introduced in 2012 because there was a suspicion of money laundering by way of high start-up valuation. But how does one explain to authorities concerned that even a business running huge losses is worth thousands of crores. If a registered venture capitalist or a fund avows for it, then that statement is accepted. Whereas individuals and angel investors do not have a similar stronghold when it comes to defending their investments.
Firms may seek international registration
Balram Nair, VP, Chennai Angels says it is matter of concern as the query is coming from the Income Tax department. So, there is a need to respond. There are cases where start-ups that we have invested in, have followed every law to the book. However, they have been dragged into hearings that have gone on for more than one year, with the initial notice coming in 2017. There are also instances where IT authorities have been able to close the matter in less than a month. It’s just the question of assessing officers working out of two different locations having a difference of opinion with regards to a certain start-up. How can the IT department have two assessing officers with varying viewpoints on the same issue? This is the time when start-ups grow, create employment and solutions and instead they spend 30 pc of their time dealing with these queries. We have been preparing start-ups with things as basic as FAQs to deal with such requirements. Few start-ups have been asking us if they could register outside India to avoid such bottlenecks that have been hounding them for so many years. We work with TiE, and have reached out to DIPP, FICCI and other bodies, and representing the needs of the start-ups here. The Centre must recognise angel networks as legitimate entities, and that no conversion of black to white money happens in such entities.
"As a first-time entrepreneur, I have no clarity on how angel tax works. I think the government should form a committee with a team of experts to look into this matter. In the current form, it will have a huge impact in the start-up funding and goes against the spirit of Startup India initiative. Having said that, I believe there is a need for regulation in the start-up ecosystem, so we can prevent any malpractices pertaining to angel funding"
— Shanmugha B Raja, CEO, Turiyatree Technologies
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