The planned reform in the angel tax scheme, which is likely to impede foreign capital for emerging firms, was unveiled in the Budget last month with no major relief for startups.

In accordance with the list of amendments to the Finance Bill, which the Lok Sabha approved on March 24, the proposed changes will take effect for Assessment Year 2024-25 or Financial Year 2023-2024.

“There was uncertainty regarding whether this goes live on April 1, 2023 or April 1, 2024. However, the Explanatory Memorandum to the Finance Bill 2023 specifies that it applies beginning with Assessment Year 2024-25, which corresponds to Financial Year 2023-24. In the Finance Act, April 1, 2024 refers to the Assessment year, not the fiscal year “said Siddarth Pai, managing partner at 3One4 Capital.

No relief for startups from a crucial angel tax provision

According to a background paper provided by the Ministry of Finance, all concerns voiced by interested parties about the execution of this plan would be addressed. “In April, the draft rules pertaining to valuation will be distributed to the stakeholders for their comments. Exclusions, as already granted to domestic Venture Capital Funds, etc., shall be considered for comparable foreign firms “the additional remark

As if the funding winter wasn’t enough of a problem, the government threw another curveball at startups with its Union Budget, as the Finance Bill, 2023 eliminated an exemption for money raised from foreign investors under the angel tax regime. However, the exemption for investments made by alternative investment funds registered with SEBI remains in effect.

According to experts, the new tax provision could have a significant negative impact on startup investments in the country by foreign investors like SoftBank, Tiger Global, Alpha Wave, and Sequoia.

The startup ecosystem continues to hold out hope for exemptions

The Central Government has the authority to do so by means of a notification. The notification is anticipated prior to April 1, 2023 so that ongoing funding rounds are not disrupted “said Pai.

“With the passage of the Finance Bill of 2023, the angel tax’s application to foreign investors has been entrenched. Only SEBI-registered CAT I and II AIFs and IFSCA-registered CAT I and II AIFs (under the IFSCA FME Rules, 2022) are immune from Angel Tax, he noted.

The angel tax system was introduced in 2012 as an anti-abuse mechanism to combat money laundering. It stipulated that a startup’s fundraise might be taxed if the funding round occurred at a valuation greater than the fair value of the shares – as established by a merchant banker.

Although the premium on share value is one of the most controversial aspects of the angel tax problem, industry groups had requested a change of the applicable angel tax regulations governing valuation. As an alternative to the present requirement of a discounted cash flow assessment, “internationally acknowledged valuation procedures” were requested.

In order to make it more difficult for bad actors to abuse concessions made for startup investments, industry bodies had proposed more stringent regulations.
They included regulating that securities of startups be stored in dematerialized form and not reporting any transfer of shares for cash, but only through checks, demand drafts, or other electronic methods.
Due to the clause, entrepreneurs and investors have expressed concern about the possibility of being harassed by tax authorities even in the event of legitimate transactions. Startups have reported receiving tax notices for angel investments raised three to four years ago. In many instances, the amount that startups must pay in taxes and late payment fees exceeds the original fundraising amount.