IMB and post April 2016 incorporation certifications must for startups eyeing angel tax exemption

Startups which have an inter-ministerial board (IMB) certification and incorporated on or after 1 April 2016 can apply to the government to avoid angel tax.

Only double-digit number out of 7200 start-ups identified have got exemptions from angel tax, outlined a Mint report quoting the Department of Industrial Policy and Promotion (DIPP) note. Around 86 startups have received tax benefits since 2012.

IMB certification is a new requirement for getting angel tax exemption. IMB will validate the innovative nature of the business for granting tax-related benefits.The profits of recognised start-ups with IMB certificates are exempted from income tax for a period of three years, it added.

The government recognizes a business as a startup or as an early-stage business only if it is less than 7 years old and have revenue less than Rs 25 crore. It is a prerequisite under commerce ministry to approach the government for any benefit as a start-up.

Last year, various startups received assessment notices from the authorities asking them to pay mind-boggling tax on funds they raised.

Many entrepreneurs including erstwhile Infosys board member and prominent angel investor Mohandas Pai had voiced his concerns over exorbitant taxation levied on angel funding. “Very bad scene and very many are angry and upset, may shift overseas,” tweeted Pai, who has invested in several start-ups.

@arunjaitley Sir Start Ups are getting harassed by IT for raising Capital,threatening to consider it as income!very bad scene and very many are angry and upset,may shift overseas.Appeal process broken, takes 15 years. Pl intervene, @PMOIndia @narendramodi @amitabhk87 @rsprasad

— Mohandas Pai (@TVMohandasPai) December 19, 2017

Besides, in January, many startups complained about getting notices from IT department post raising angel investment. Startups had filed a petition through Change.org against angel tax demanded by the income tax department. The petition was filed by Sreejith Moolayil, co-founder of food brand, True Elements.

A founder who is part of the group behind this petition hasn't taken salary in 18 months. #startup is cash positive with a bank balance of just 8L. Now has to pay 80L as tax on angel raised. #savestartup https://t.co/hoFqqwoRkD

— Sreejith Moolayil (@sreejithmoolayl) January 19, 2018

The number of notices and assessment orders from the tax department contradict the spirit of startup India movement as they are becoming an impediment for ease of doing business in India, said experts of the industry. They also termed the new criterion for making IMB certification essential, as adding to existing woes, in the issue. It will confuse investors as well as startups.

The controversial angel tax was introduced in 2012 and applies to capital raised by unlisted companies from any individual, including angel investors, against an issue of shares in excess of the fair market value (FMV). In its current form, funds from angels are taxed at over 30 per cent if it is more than the FMV.

The so-called angel tax can be explained in another way. Though a rights issue is typically at lower valuations, startups also see drops in valuations after the funding. Now, looking back, it appears the rights issue was made at a valuation in excess of fair value. This leads the tax department to levy taxes on the difference, which is considered to be income and deemed taxable under Section 56 of the Income Tax Act.

This year Union Budget had spoken of facilitating the growth of start-ups, raising the hopes of angel investors who felt the government would soon fulfil their long-standing demand—an exemption from angel tax for all start-ups.

However, the current form of rules for angel tax exemption with new criterion has a lot more clarification to do before it can actually address the actual concern of startups and investors.