In a major respite to India’s fledgling start-ups, Finance Minister Nirmala Sitharaman announced scrapping of the contentious angel tax on foreign investments received by such enterprises, a development that is expected to ease their funding woes. Ms. Sitharaman introduced the measure stating that it would help “bolster the Indian start-up ecosystem, boost the entrepreneurial spirit and support innovation”. 

The tax was introduced during the UPA regime, she said in a media briefing on Tuesday while outlining measures the NDA government took for the growth of start-ups.

Replying to queries on the possibility of money laundering due to the abolition, Revenue Secretary Sanjay Malhotra said, “There are other provisions in the Income Tax (Act) itself to find out the source of these funds.”

The Prevention of Money Laundering Act continued to be in existence. The existent laws were sufficient to cater to it, Mr. Malhotra added.

“We hope that even some of the past investments which are not already under dispute will probably have a little more benign outlook from the tax department,” Ashish Aggarwal, Vice President & Head of Public Policy at NASSCOM, told The Hindu.

“This new development will lead to a cessation of fresh litigation. Furthermore, funds that would have been tied up in deposits for cases involving notice issuance cease,” said Brijesh Damodaran, Partner at Auxano Capital.

The abolition of angel tax assumes significance as it comes at a time when start-up funding fell 60% in 2023 to $10 billion, according to data on the Indian Tech Startup Funding Report 2023 by Inc42, a private start-up media and information platform. The decline is more than 40% in 2022.

The tax was opposed by several industry players as they believed it curbed foreign investment and deterred the growth of start-ups . Angel tax was originally introduced in 2012 to curb possible money laundering by foreign participants, by investing in overvalued unlisted firms. The unintended consequences were faced by start-ups, for which investments are made based on the potential value of the business, unlike in regular firms that are valued on their current worth.

The move imposed tax liabilities in the incubation and early funding stages of start-ups, deterring their growth. “This decision is a welcome step towards providing tax certainty, preventing unintended consequences on foreign investments, and supporting startups,”said Rahul Charkha, Partner at a legal firm Economic Laws Practice. 

Despite opposition from various stakeholders, including the Department for Promotion of Industry and Internal Trade (DPIIT), the government held on to levying angel tax. Moreover, the income tax rules amendments in September 2023 included changes in calculating fair market value of shares and a threshold for considering a share as “overvalued”, among others. One of the main intentions of the amendment was to bring in parity between domestic and foreign investors.