From the Viewsroom

Angel tax needs sanitising

Vivek Ananth | Updated on September 09, 2019 Published on September 09, 2019

Linking exemption for start-ups to end-use of funds is restrictive

BL Research Bureau

The start-up community heaved a sigh of relief when two weeks ago the Finance Minister announced that the dreaded section 56(2)(viib) of the Income Tax Act would not be applicable to start-ups registered with the Department for Promotion of Industry and Internal Trade (DPIIT). Income tax under this section was referred to as ‘angel tax’. There are still some niggling issues, but first a recap of how we got here.

The section in question was originally meant to snag illicit payments routed through companies by inflating the prices of shares, which were then sold to investors. Start-ups got dragged into this quagmire as more and more companies raised money at high valuations. The law was applied mechanically, and notices issued to hundreds of start-ups. The DPIIT and the Central Board of Direct Taxes (CBDT) worked to evolve a solution. Based on certain conditions, start-ups would be approved and then exempted from the dreaded ‘angel tax’. Initially, the income tax officials didn’t take cognizance of this resolution because the CBDT didn’t issue them directions. Then in March 2019 the directions were issued, but the pain persisted for start-ups. Then came the August announcement by the Finance Minister, Nirmala Sitharaman. One of the conditions in DPIIT’s February 2019 notification for exemption of ‘angel tax’ was end-use of the funds raised. Start-ups can’t invest the funds in certain assets. These include “shares and securities” or “loans and advances”. The intention is to stop the flow of unaccounted money through the exemption carved out for start-ups, but these restrictions have created problems. Most start-ups park the funds they have raised from investors in mutual funds till the time they actually need them.

By putting a stop on this, their operational freedom is restricted by the government. Once the exemption from ‘angel tax’ is given, the end-use restrictions will disallow a start-up from acquiring a smaller company to expand its business or from giving advances to their employees. Rather than micro-manage how start-ups operate, the government should promote entrepreneurship. Such conditions should be eased to give operational freedom to companies.

 

Published on September 09, 2019

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