What is Angel Tax?
Angel tax, also known as the angel investment tax or the Section 56(2)(viib) of the Income Tax Act, is a tax that is levied on the excess capital raised by a startup through the issue of shares to external investors at a valuation higher than the fair market value.
How Angel Tax Works
When a startup raises funds from angel investors, venture capitalists, or other sources, the tax authorities may scrutinize the valuation at which the shares were issued. If they determine that the valuation is higher than the fair market value, the excess amount is treated as income and taxed at a rate of 30%.
Example of Angel Tax
For example, if a startup issues shares worth Rs. 1 crore to an angel investor at a valuation of Rs. 5 crore, but the fair market value is determined to be Rs. 3 crore, the excess Rs. 2 crore will be subject to angel tax at a rate of 30%.
Case Studies
- Case Study 1: Startup A raises funds at a valuation of Rs. 10 crore, but the fair market value is Rs. 8 crore. They are taxed on the excess Rs. 2 crore.
- Case Study 2: Startup B raises funds at a valuation of Rs. 20 crore, but the fair market value is Rs. 15 crore. They are taxed on the excess Rs. 5 crore.
Impact of Angel Tax
Angel tax has been a major point of contention among startups and investors in India. Many argue that it hampers the growth of early-stage companies and discourages angel investment. According to a report by Inc42, angel investments in Indian startups dropped by 39% in 2019 due to concerns over angel tax.
Conclusion
Angel tax is a complex issue that has significant implications for startups and investors. It is important for policymakers to address the concerns raised by the startup community and create a more favorable environment for angel investment to thrive.
