Removal of the Angel tax for startups was a long pending issue as this levy was on investment coming into the country and such overseas inflows should not be taxed, a top government official said.

Rajesh Kumar Singh, Secretary, Department for Promotion of Industry and Internal Trade (DPIIT), said the decision will help in attracting foreign investments, promoting innovation and further strengthening the startup ecosystem of the country, which is the third largest in the world. “So this was an ease of doing business issue as well as a tax issue. Ultimately, it was a tax not on income but on investments and investments should not get taxed, that is the basic idea,” Mr. Singh told PTI.

Giving a big relief to startups, the government on July 23 announced the removal of angel tax for all classes of investors. The decision will also reduce disputes and litigation, thereby providing tax certainty and policy stability. Besides, it will also bring down the demand embroiled in assessment and litigation.

Angel tax (income tax at the rate of over 30%) refers to the income tax that the government imposes on funding raised by unlisted companies, or startups, if their valuation exceeds the company's fair market value.

Explaining the rationale further, Mr. Singh said that the tax hurt investors. Because of that tax, a “genuinely good” idea was not getting supported in India and it was forcing people to flee abroad and get their money. “So actually it reduces FDI (foreign direct investment) into India and it also creates a system where people domicile themselves outside the country and then after a long time they come back because ultimately the market is here,” he noted.

On the concerns about money laundering issues in such investments and why an investor pays a premium to only an idea of a startup, Mr. Singh said that those matters can be handled through other legislation which already exists. “You are trying to tackle 1-2-3% of people who are doing that [money laundering], but you are burdening 97% people who are genuine innovators and trying to sell an idea and get investments for it,” he said.

The angel tax was forcing startups to approach foreign investors and now after the removal of this clause from the Income tax act, budding entrepreneurs would be able to raise funds.

Bid to attract investments to Indian startups

Commerce and Industry Minister Piyush Goyal also said that the decision will help attract investments in Indian startups and further promote the growth of budding entrepreneurs. The move would mainly help emerging sectors like deeptech, artificial intelligence, clean energy, among others, which require a large amount of capital at an early stage.

Section 56(2)(viib) of the Income Tax Act provides that the amount raised by a startup in excess of its fair market value would be deemed as income from other sources and would be taxed at 30%.

Touted as an anti-abuse measure, this Section was introduced in 2012. It is dubbed as 'angel tax' due to its impact on investments made by angel investors in startup ventures.

Earlier also, the government has made several amendments to make this tax regime more conducive for investors and startups. A change was made under the Finance Act 2023 proposed to include investments from foreign investors or non-residents within the scope of the angel tax with effect from April 2024.

Certain exemptions notified by the Central Board of Direct Taxes (CBDT) stated that the provisions do not apply to DPIIT-recognised startups, certain classes of foreign investors, and entities from 21 nations. Further, guidelines regarding valuation methodologies were also notified by the CBDT.

However, it was felt that the provisions were hampering the industry at large, the growth of the startup ecosystem, particularly inbound investments, an official said.

Joint Secretary in the DPIIT Sanjiv said that multiple representations were received by the department from stakeholders concerned, highlighting the potential adverse impact of the angel tax. Before suggesting the removal, the DPIIT officials studied various international regimes and their approaches were analysed by them, he said.

For investors, this move would infuse confidence into India's investor community and is expected to remove a lot of the risk for investors in very early-stage companies, leading to an increase in the number of overall active investors in India, he added. As on date, about 1.44 lakh startups are recognised by the DPIIT.