” And the angels who did not keep their positions of authority but abandoned their proper dwelling—these He has kept in darkness, bound with everlasting chains for judgment on the great Day”
Will Feb 19, 2019 be that great day? The word ‘angel’ sends shivers down the spine of any entrepreneur – an emotion quite contrary to what angels evoke. The killjoy here, again, is the taxman! The past few months have brought stories of startups in distress – Travel Khana being one of them. Entrepreneurs and the entire startup ecosystem have been clamouring for change. G.S.R. 34 (E) dt. 16 Jan 2019 helped little (read our analysis here – https://bclindia.in/startup-angel-tax/). Startups needed more!
Recognising the urgent need to provide relief, the Ministry of Commerce and Industry issued latest guidelines vide G.S.R. 127(E) [read full notification below]. The notification covers angel tax (u/s 56(2)(viib) of Income Tax Act) in detail.
Let’s first look at the major change proposed in the definition of a ‘startup’
- The definition of startup has been widened to now include companies, LLPs and firms not older than 10 years. Earlier notifications allowed for only 7 years (10 only for those in biotech sector).
- Turnover threshold has been enhanced from Rs. 25 Crores to Rs. 100 Crores. This will undoubtedly help many more businesses than before.
Let’s now look at ‘angel-tax’ modifications
- Declaration & not application
- The subtle change in the language of the latest notification will be the biggest benefit. The regime has moved from one requiring ‘application’ for recognition of benefit to ‘declaration’ of availing benefit!
- The notification grants automatic benefit to the startup on fulfilment of conditions. The startup has to only submit a declaration in Form 2 to claim ‘angel-tax’ exemption.
- Sec. 56(2)(viib) reads – Provided that this clause shall not apply where the consideration for issue of shares is received— (i) by a venture capital undertaking from a venture capital company or a venture capital fund; or (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf. The latest notification begins with the delightful sentence “A Startup shall be eligible for notification under clause (ii)…”
- Thus, fulfilment of conditions = exemption. No further approval is needed (caveat – there are differing opinions in the industry; time will bring in more clarity).
- Aggregate paid up capital limit
- The limit of funding has been enhanced from Rs. 10 Crores to Rs. 25 Crores. This is a significant jump and will be of great help.
- What’s more, the cap of Rs. 25 Crores will not include funding from
- Non-residents, and
- Venture capital funds, both of which are exempt from the rigours of 56(2)(viib). It was only logical to exclude these investments from the cap proposed.
- In addition, funding from large domestic listed companies have been exempted! Thus, three sources of funding are now fully exempt from the rigours of angel-tax (a) from non-residents, (b) from VC funds / companies and now, (c) from listed domestic companies. Given the exemption, funding from such listed companies will not form part of Rs. 25 crore cap.
- The introduction of this clause will encourage domestic companies to invest more money in home grown startups. These large listed companies (previous year net worth > Rs. 100 Cr., or turnover more than Rs. 250 Cr.) will boost funding and provide great fillip to the entire startup ecosystem.
- Investor proof of income and financial strength removed
- The startup no longer has to prove that the investor has the financial backing to invest in the company. Income tax returns and net worth statement of investors are a thing of the past now.
- Previous notifications recognised only investors achieving minimum income levels of Rs. 50 lakhs / net worth of Rs. 200 lakhs – a daunting task if the investor booked losses. This has now been done away with.
These three major changes will without doubt be of great help. It is worth noting that the requirement to submit merchant banker certificate had been done away with in the previous notification itself. The latest notification too does not call for any such certificate.
One cannot be too optimistic while reading government notifications. You would have realised by now that all this is ‘too good to be true’! Well, you are right to some extent. There are indeed some drawbacks.
- Additional restrictions
- This notification introduces a new (rather convoluted, & I daresay poorly drafted) clause that governs how the startup should invest its funds!
- Any investment into land & building (other than for own use, renting or as inventory), securities, loans, capital contributions is prohibited. What’s surprising is that startups should not own motor vehicles of value more than Rs. 10 lakhs unless it is used for plying, hiring, leasing or as stock in trade. This may be a cause of concern to startups owning goods transport vehicles or motor vehicles for own use. PS: folks at Ola! & Uber will be happy.
- The restriction placed is not just for the year of funding, but for 7 years from the year in which funds are received & shares are issued at premium!
- Questions that arise
- Can a startup continue to give loans to its employees if it has to qualify for exemption? The prohibition only exempts loans by the Startup where the lending of money is substantial part of its business
- Can the startup park excess funds in liquid mutual funds? Should the startup abandon acquiring 100% stake of a competitor in fear of losing exemption because investment into securities is banned? Can the startup set up a subsidiary or a joint venture?
- Can the startup work in these restrictions for 7 long years! If a prohibited investment happens in the 7th year, will the startup be called upon to pay taxes for the premiums received in the 1st year?
- No relief if assessment is closed. No relief from 68 – angel-tax’s evil cousin!
- The notification is categoric in its refusal to provide relief to startups penalised with orders adding back super-premiums. The only option available to the startup now is to appeal against the order of the assessing officer.
- Though the notification will have retrospective effect, startups reeling under dubious orders or suffering with blocked bank accounts have no recourse other than appeal.
- Finally, no relief from classification as ‘unexplained credits’ under Sec. 68 has been offered. Thus, the officer may still tax the premium u/s 68 – like the case with Travel Khana!
Again, it seems like bureaucracy has trumped good intentions. Additional restrictions, stretching out into the future, water down many positives which this notification had. Without these clumsily drafted restrictions, this notification would have indeed called for the biggest ‘hurrah!’ that startups have stifled for too long now. The judgement day is elusive as ever!
You can read the full notification here198117