Context: In the latest budget, the government has expanded the scope of Angel tax to cover foreign funding. This proposal has created uncertainty among the entrepreneurs.
Angel tax refers to the income tax (30.6 %) imposed on any unlisted company (usually startup enterprises) in receipt of investment which is above the fair market value. Such investment is treated as income from other sources for the tax purpose. This tax was introduced in 2012 in the form of Section 56 (2) of the Income Tax Act to plug money laundering practices.
Earlier, angel tax provisions were applicable only for investments received from resident investors. However, Finance Bill 2023 has extended its applicability to non-resident investors as well.
Issues with Angel tax:
- Assessment of Fair market Value: Calculating a startup’s fair market value is subjective and based on negotiations between the startup and investor. Whereas the tax authorities compute the market value based on Discounted cash flow method. The market value arrived under this method tend to be lower than the value agreed by the start-up and investor.
- The proposed amendment may deter foreign investors from investing in India and lead some start-ups to consider restructuring their holdings overseas to avoid pressure from concerned foreign investors.
Stringent tax laws like these may result in flipping of start-ups.
Flipping & Reverse flipping:
Flipping refers to an Indian company transforming into a 100% subsidiary of a foreign entity, after it has moved its headquarters overseas, including a transfer of its intellectual property (IP) and others. The same process, but moving back to India, from another country is known as “reverse flipping”.