India is finally closing the books for a long-standing dispute that has affected the country’s booming startup industry, after the country has decided to exempt startups from paying “angel tax” which requires small businesses and startup companies to pay for a special tax if they receive an investment that is bigger than their “fair market valuation.”
In an effort to boost the country’s economy, which has been subjected to a five-year low, Finance Minister Nirmala Sitharaman said that India is now exempting startup companies from Section 56(2) of their local income tax laws.
In the past, tax authorities in India use a different valuation computation to determine the value of the company. Tax authorities rejected the discounted cash flow method, which many investors are using to value a certain startup, and instead value them using their current worth. The valuation made by local tax authorities in India is significantly lower as compared to the valuation made by investors because the investors are judging the value of the company based on its potential value in the future.
The “angel tax,” which was announced to have startups exempted from, levied 30% for startups who received funding and investments more than the fair market value of the company – a value determined by computing how much the company is worth now.
Sitharaman said any startup that is registered with the Department of Industrial Policy & Promotion, a government body, will no longer be required to pay the angel tax. But those that are still not registered to the body will still be subject to the tax, he said in a statement.
As of today, there are more than 24,000 startups registered to the Department of Industrial Policy & Promotion, which was initially established to protect people from investing in bogus startups and use them for money laundering.
“Angel tax was there to stop shell companies from creating capital from nowhere,” Piyush Goyal, a minister for commerce and industry as well as railways, said in a statement Friday.
The announcement by the country’s Finance department comes weeks after New Dehli’s Narendra Modi announced that the government would address the issue, which has affected thousands of startups and have prevented many of them from acquiring early-stage funding.
Opposition to the tax, which was implemented since 2012, from startup companies, analysts and other industry executives have since poured out citing that the policy will only hurt the startup ecosystem and will disincentivize founders from taking their ideas further and building their companies out of it.
Back in 2018, India’s tax department sent a notice to different Indian startups demanding them to pay the angel tax on funds they received from individual investors. The move earned massive uproar from the startup community, with people calling it “harassment.”
“Hope this will address the concerns of DPIIT registered startups. The proposed cell should look into concerns of all startups, including those who are already under notice,” said Ashish Aggarwal, who oversees Public Policy at industry body Nasscom, of today’s announcement.
Furthermore, Sitharaman said that the department would set up cells that aim to address the different issues that the startup community in India face nowadays. “A startup having any income-tax issue can approach the cell for quick resolution,” the ministry said in a statement.
Jayanth Kolla, founder, and chief analyst at research firm Convergence Catalyst said that the angel tax is one of the primary reasons why early-stage startups find it hard to find funding from investors. The amount of funding for startups has also declined.
While tech startups from India received a total of $10.5 billion of funding in 2018, many early-stage startups in the country are struggling to find investors with a significant drop in the amount of capital they received.
Data revealed that India’s early-stage startups participated in 304 deals in 2018 and raised $916 million in funds last year. The year before that, startups in the country raised $988 million from 380 rounds in 2017 and $1.096 billion they raised from 430 deals the year before.
The move of India’s finance department has been applauded by key players in the startup community. Anand Mahindra, the founder of Mahindra Group, said in a tweet that the government’s “willingness to relook at policies is a display of strength.”
“Holding a press conference & announcing a slew of measures instead of a ‘trickle of tweaks’ was smart communication. It garnered global attention & signaled Govt’s recognition of the gravity of the situation & an intent to reignite sentiment & growth,” he said in a tweet.