What is Angel tax?

Angel tax is the income tax that unlisted companies or start-ups are liable to pay on a capital raised through issue of shares, in this case normally the share price is more than the fair market value of the shares sold. The excess money thus generated is treated as taxable income. This was introduced in the union budget of 2012 with the aim to decrease laundering of money. This tax applies to only Indian investors.

To explain it in an easier way, there are many unlisted companies or start-ups that are doing unusually well and many people are waiting for their first listing of shares, with a lot of enthusiasm. This is perceived by the companies and in order to benefit from this positive sentiment towards their company, they price the issued shares, higher than the fair market value. Now in this scenario, the unlisted company has to pay taxes on the difference between the value that they set for the shares and the fair market value of those shares. The tax rate is about 30%.

As harsh as this may seem, there are certain exemptions that have been provided. There are certain criteria that the start-ups need to meet in order to be eligible for this exemption. They are as follows;

1. After the issue of shares, the paid-up capital and the share premium should not exceed Rs. 10 crores.

2. A merchant banker should give the start-up a fair market value certificate.

3. The minimum net worth of the investor should be Rs. 2 crores and also, the average income in the last 3 financial years shouldn’t be less than Rs. 50 lakhs.

4. Lastly, the start-up needs to get an approval from 8-member inter-ministerial board for angel tax exemption.

Recently in 2018, in order to make the procedure simpler, the government has done away with the fair market value certificate and the board approval. The start-ups can now just file a request with the related documents, and this will be either approved or declined within 45 days.

Let us try to understand the method of taxing. If a start-up received 40 crores of investment by issuing 1 lakh shares at Rs. 4000 each to an Indian investor and the fair market value is Rs. 3000 per share, that is, Rs. 30 crores only. In this case the start-up will have to pay angel tax on the excess amount of Rs. 10 crores. Hence, the angel tax paid on this particular transaction will be Rs. 10 crores* 30.9%= Rs. 3.9 crores.

So why is the start-up community opposed to this?

The income tax department calculates the fair market value on the net asset value of the company, not taking into consideration the growth rate or the future projections obtained by this growth rate. This leads to an increased difference between the fair market value (as calculated by the income tax department) and the value at which the shares are issued, and thus leading to a higher amount of angel tax to be paid. This will wipe out or decrease the excess money obtained by the company or start-up which would have otherwise been used to further develop the company, capital restructuring etc.

On 24th may, 2018, the government acknowledged and agreed to a demand made by the start-up community and announced that all angel investors will receive a total exemption on angel tax. This is only for start-ups and not for unlisted companies. Usually around 300-400 start-ups are funded by angel investors in a year, and this decision will make it a lot easier to get funding as well as for the start-up to grow to its fullest potential.