The abolition of the angel tax in Budget 2024 of India has been termed as one of the major reforms that will benefit the startup ecosystem immensely. Announced by Finance Minister Nirmala Sitharaman, the move has largely been welcomed by VCs and industry experts who feel that the abolition would ensure a more nurturing investment climate for startups.
Know About Angel Tax and its Impact
The angel tax, introduced in 2012, was levied on the excess value received by a company over the fair market value of its shares from a foreign investor. It was supposed to prevent money laundering but ended up having unintended consequences for genuine startup investments. For example, if a startup raised ₹10 million with a fair market value of ₹8 million, this excess of ₹2 million was taxed, laying a financial burden on the company.
Problems Startups Faced Because of Angel Tax
Burden of Proof: The department singled out startups frequently to prove their valuation before tax authorities, most often embroiling them in litigation and other protracted legal procedures. The tax was applied even if the valuation was based on genuine future growth prospects.
Investor Hesitation: The probable taxability made investors wary of investing in startups, especially at higher valuations. This hesitancy reduced the availability of much-needed capital for early-stage companies.
Administrative Challenges: The compliance and documentation requirements to prove that investments were genuine added to the administrative burden on startups, diverting resources from core business activities.
Benefits of Abolishing Angel Tax
Boost to Startup Investments: Its removal is most likely to ease the flow of capital into startups, making it more attractive for domestic and international investors. According to experts like Harsh Bhuta, Partner at Bhuta Shah & Co LLP, it is in sync with the government’s Startup India initiative and will further facilitate the ease of working in a more robust and dynamic startup ecosystem. It is expected to encourage more job creation, innovation, and economic growth, moving toward the $5 trillion economy target.
Incentivising Foreign Investments: The most significant is exempting non-resident investors from the angel tax. This should see more foreign capital come in, which is essential for the scaling up of startups. “This change brings more clarity and flexibility to investors and startups, and incentivizes foreign investment and increases India’s competitive standing in the world,” said Karthik Reddy, Managing Partner, Blume Ventures.
Burden of Compliance Reduction: There were several compliance-related issues concerning valuations faced by startups earlier, such as arguing with tax authorities for justification. Abolition of the tax brings down this burden, helping startups focus more on their core business activities rather than on the bureaucratic processes involved. The change is hence likely to reduce financial and operational pressures on startups, enabling them to grow and innovate freely.
Expert Opinions
According to Narinder Wadhwa, managing director of SKI Capital, scrapping angel tax is one big step towards an enabling environment for startups and investors. “This removes a big hurdle that has more often than not resulted in litigation and has turned away some possible investments,” he said. He added that this would bring about confidence among investors, especially when the world is facing an economic slowdown. There is a need felt now to simplify and reduce taxation liabilities to make India a more attractive destination for startup investments.
Experts agree that the abolition of angel tax is going to be a game-changing step toward the Indian startup ecosystem. This would address pending issues and provide the much-required impetus for the investment climate. Thus, this reform would put Indian startups on new growth trajectories of development, encouraging domestic and foreign investments that will play a major role in the economic development of the country.