The major problem with this tax is that it affects both the investor and the seller of a startup; the tax becomes a contingent liability.
As anyone who knows anything about starting a business will tell you—it’s a journey full of risk—especially so in the ultra fast changing digital landscape where an idea could become a big hit overnight and yet be outdated by new emerging technology in the same time space. For politics, a week is a long time for startups it could be a day.
India’s ever present goliath bureaucratic extraction state system has added a huge new risk for startups—it has sent tax notices to an estimated 80% of angel investors—those investors that put money in a startup up at the very earliest nascent state. In some cases, like the start up Travel khana the central board of direct taxes withdrew Rs 36 lakh as angel tax on account of a tax order of Rs 2.3 crore issued in December 2018, leaving the startup in such a bad shape that it had trouble paying salaries.
Amitabh Chaturvedi, Founder of the corporate law firm Mine & Young, says, “Look, there is an environment of fear out there. Many startups are not only issued notices, their chartered accountants have been called in for questioning and the reason is simple—these firms cannot be evaluated on the usual metric of assessing fair business value. These just do not apply in tech-oriented risk. The rub is that while revenues remain neutral or even go down, the valuations can go up in some startups. This is because the investor is looking at the transformative future of a startup.”
He has a point. Amazon—the marquee startup reported $1.9 billion in net profit on $51 billion in turnover for the last quarter of 2018, a 3.7% profit in the same quarter its market value crossed $1 trillion—India’s entire GDP is $2.5 trillion. This is a different ball game; if the angel tax existed in the USA, you can be sure that Jeff Bezoz would probably have been a delivery boy at best
Fair business value refers to the traditional metric of assessing tax and requires a look at sales, profits and margins. These are all but absent in angel investing that looks at the potential of a technology in the years ahead.
Rahul Garg, Founder and CEO of Moglix, a thriving industrial goods online marketplace, calls for simply killing the tax. Says he, “In order to promote and encourage the start-up ecosystem, we need angels. If the regulatory compliance is complicated, angels shall find it tough to support startups during the formative years and hence a favorable climate must be maintained. The Startup India initiative was launched to promote innovation and entrepreneurship and the abolition of ‘Angel Tax’ will further provide the much needed impetus in the entire scheme of things. ‘Entrepreneurship’ and ‘Start-ups’ are the new buzzwords and besides creating millions of direct and indirect jobs, they can significantly contribute to change the narrative of country’s growing economy.”
The other major problem with this tax is that it affects both the investor and the seller of a startup. The tax becomes a contingent liability, dragging down any profit that the parties can make as the tax value has to be provided for when a transaction takes place, So, for example, if it is a Rs 10 lakh tax liability—and an angel investor is making a Rs 50 lakh profit on a deal—that becomes a Rs 40 lakh profit, with the tax becoming a mark to market liability.
Girish Shivani, who runs YourNest, an early stage venture capital fund that has about 20 investments in India each with an average size of $1-5 million, says, “The Angel tax is a bad idea. It has created uncertainty and especially cramped high net worth individuals, who are pioneers in some sense as they do very significant first stage investments. Valuation and share premium is the way value of a startup is pegged. The old structures of bookkeeping do not apply so easily in the startup world. India needs to seriously rethink the whole tax on startups if it is not to suffocate an industry that is prepared to take on even the Silicon Valley in ideas if nurtured properly.”
Rakesh Nangia, Managing partner of the tax firm Nangia LLP which has advised several startups as well as investors, says that the government needs to course correct. He says, “The government should device a mechanism that effectively addresses the basic premise of Angel tax i.e. controversy around valuation of shares.
Among the other things, the government should consider revising the threshold limit of the funds raised by start-ups to claim exemption.
The startups are under the requirement to take the approval separately while raising each set of investments. The approval being investor specific, might prove to be the biggest complication in the “ease of doing business in India for the startups”.
So the message from the Indian startup entrepreneur is simple—kill the tax, or face the rage of angels. Time is running out for India, especially with reports that China is considering a tax rebate and Australia already offering one for technology sector startups.
Ninad D. Sheth is a senior journalist based in New Delhi.