Funding crunch. Start-up industry seeks exemption of certain investor classes from angel tax amendment

Following the amendments proposed by the Finance Minister to angel tax provisions, industry bodies representing PE-VC industry have approached the government seeking exemption of certain investor classes from the tax provisions.

The Finance Minister had proposed in the Budget that the extra premium received by an unlisted company in India by the sale of shares to a foreign investor will be recognised as “income from other sources” and will be taxed. As per the rule, any extra premium that the investor pays over the start-up’s fair market value (FMV) will attract a 20 per cent tax. 

Speaking to businessline, Siddarth Pai, Co-Founder, 3one4 Capital & Co-Chair, Regulatory Affairs Committee, IVCA (Indian Venture and Alternate Capital Association), an industry body representing the interests of the PE-VC community, said a number of bodies have made representation to the government on the issue. Everyone has gone with the expectation that the government will exempt certain classes of foreign investors from application of this particular section. 

Vinod Shankar, Partner, Java Capital, said there should be some kind of process for foreign investors to get the same exemption that are available to the domestic investors. 

The IVCA has also sought exemption for global PE, VC and hedge funds that are regulated by globally recognised securities regulator like the International Organization of Securities Commissions (IOSCO). It is a multi-lateral organisation, that consists of securities regulators of various countries.

“IVCA’s ask is to exempt investors who are regulated by a entity that are part of IOSCO. Further, we have also sought exemptions for listed entities like Google, Meta and investments made by sovereign funds, pension funds, university endowments etc,” Pai added. The industry expects the exemption list to come by early March. 

Ashitha Bhagwan, Managing Partner at Inventus Law India, said the biggest concern is that investments are being recognised on the same lines as the company’s revenue. 

“These are companies that have proprietary IP that doesn’t necessarily have revenues in the current stage and so, their fair market value will be very different from what the investors predict to be company’s potential valuation. This is because the potential valuation is based on many future aspects,” she added.

Investors are worried as to how the company reconciles the difference between fair market value and the price that they have paid. “Since the price that the investors are paying is based on future potential while the fair market value is based on the current value of the company, there is an immediate tax consequence due to angel tax irrespective of the fact that the company did not recieve any income,” she added.

Can intensify funding winter

One of the major reasons for the ongoing funding winter in Indian start-up ecosystem has been the conservative outlook of the global investors, who have usually been the lead investors in big funding rounds in the country.

Experts say that the start-up ecosystem could see a rather intensified funding crunch if the proposed angel tax provisions are implemented, as it will add uncertainty to the already volatile macro environment. 

To bring uncertainty

Adding to this, Ankit Kedia, Founder & Lead Investor, Capital A, said: “This new amendment also brings uncertainty in the minds of founders, wherein they will need to assess their previous funding rounds before deciding to raise foreign funds. While start-ups in the early stages of their funding journeys can navigate these regulations by opting for plain vanilla equity round structures, those who have already raised capital on a convertible structure may encounter difficulties in attracting non-resident investors in subsequent rounds.”

Similarly, Shankar said that it is now a question of taking risk for the founder to raise funding and then later have an income tax officer coming and asking the start-up to pay taxes because they think the company did not raise funds at a fair valuation. This would intensify the ongoing funding winter.

Investors also believe that if the angel tax amendments are not changed, the provisions can trigger more start-ups to flip their domiciles to foreign locations as this will allow them to raise capital from foreign investors without being subjected to angel tax.

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