Nearly 70 start-up founders and Indian software produce consortium iSPIRT have written a letter to Prime Minister Narendra Modi looking for instant interference on the ongoing ‘Angel Tax’ scrap between the income tax department and start-ups. Start-up founders have cautioned the government that if the issue is not determined straight away, Modi’s ‘Startup India’ group could be derailed forever.
With close to 39,000 start-ups having raised around $38.5 billion in the last four years, start-up population has claimed in the correspondence to have shaped a value of close $130 billion dollars in India along with ample employment opportunities. The letter has also quoted a survey by Local Circles, where 38 percent of start-up founders have admitted to having received one or more IT notices in 2018, making the situation grave compared to last year.
Section 56 and 68 of the IT act, empowers the department to demand taxes from start-ups for currency raised by them from individuals (angel investors) for the issuance of shares (at a premium value) above the ‘fair market value’.
The start-ups will also have to furnish in order of the investors counting individual details as IT returns and net asset value of the shareholder to please the assessing officer, to consider the speculation as a bonafide transaction.
The entire ‘Angel Tax’ issue ongoing precipitating two years ago, when start-up founders were sent demand notice by the Income Tax department, mainly under section 58 to clear the dues. The notices required founders to pay the difference between the fair value and the premium at which the amounts were raised from angel investors through a share sale. Sreejit Moolayil, co-founder of True Elements says, “Start-ups in an angel round classically rise around Rs. 50 lakhs to 2 crores and not more. With most companies disappearing within 1000 days of starting up, getting a notice after 3 years makes no sense”. With DCF or inexpensive cash flow method not widely conventional by the assessing officers, “The junior officers are thinking that if we have raised money from angel investors, it’s an uncertain transaction” he adds.
At around the same time last year, when start-up companies started receiving notices, India’s noted angel investors like Kris Gopalakrishnan, Mohandas Pai and Indian Angel Network (India’s largest angel network forum) had raised their anxiety with the commerce ministry, DIPP and also Finance ministry over the provisions.
“When we sent a demonstration to the government last year, they guaranteed that there would be no coercion and again it has come up now with the next year’s appraisal being done by the department,” said Mohandas Pai, Founder, Aaron capital.
As a quick fix remedy, several notifications with clarifications have already been issued to date either by the DIPP or CBDT. The notification issued in April 2018, mandated start-ups not only to record with DIPP but also seek approval from the inter-ministerial board or IMB before raising funds to keep the speculation off IT radar.
“When someone is enthusiastic to fund a brilliant idea, should a founder start work or should he take approval from IBM before preliminary work and then receive the fund to start work? ” he asks. Most start-up founders say that with the inter-ministerial board sitting just once a month for clearances, the waiting period for approval is anywhere between 3-6 months. This period can be a death knell for early stage start-ups that are looking for survival through angel investment and bring the company to some scale for the next round of financial support.
Even if we are to go by the government’s own status report, though DIPP has recognized a total of 14,036 start-ups under its sunshade, a mere 91 start-ups have been accepted for availing tax benefits by IBM, as of the 3rd week of November 2018.
According to a group of six start-up founder, who is spearheading the movement to end this law, of which Sreejit is also a part, over 2000 notices have already been slapped this year. But the problem lies very much at the heart of the Income Tax Act.
“The recent DIPP circular cannot supersede the section,” says Pankil Sanghvi, Partner, Tax and Regulatory Services, BDO. The fundamental query of the veracity of valuation still needs to be addressed and till then the tax officials are well within their rights to get well the dues, by the letter of the law. “If a start-up company wants they can confront this in a writ petition and at the jurisdictional high court or the CIT appeal and then ITAT like any regular tax appeal,” he adds.
In the present scenario, the planned sections were never meant to be applied to start-ups. “When a tax is unjustly applied the only remedy is take it off the law. The other reason being, now with GAAR under Indian law effectively dealing with malafide transactions, the utility of the clause in fewer than 56 and 68 simply does not exist,”says Vivek Gupta, Partner, and head, M&A, KPMG India.
The problem for start-ups is not just the unwieldy fulfillment process but also lack of sympathetic on the part of policymakers and tax organization on how start-ups work. Moreover, these provisions are attracted by start-ups registered in India and angel investors in India, making this unfairly skewed in a rather flattish start-up world where big-ticket funding is coming from foreign investors.
“Out of the $13.7 billion dollars funding that India got last year, only 10 percent came from India, we are on the way to becoming a digital colony. If you go after angels who are invested, they will simply stop investing,” says Mohandas Pai.
Industry experts believe that interference by the government should be minimal. “Most of the start-ups, if they get backing and they are successful, are already doing several filing under various laws. The data is already obtainable with the regulator to take action against errant,” says Vikas Vasal, Partner, Tax, and Grant Thornton LLP India. “If we have to give confidence private enterprise to increase employment, these kinds of cases become a deterrent,” he adds.