Angel Tax Exemption under Startup India Scheme

Newly formed innovative startups are usually looking for investment opportunities. There are various kinds of investors out there that help startups in establishing their business models. Angel tax exemption is one of the many benefits of the startup India Scheme. A concept that allows the DPIIT-recognised startups to acquire angel investments and get an exemption.

What is angel tax? 

Startups are innovative and the entrepreneurs are hard workers. Yet, the thing they lack most is working capital. The only issue faced by many startups is the lack of cash flow. This leads them to look for investors. Now, when they are on this hunt, most realise that it is the easiest to get angel investors on board, rather than huge venture capital firms. The reason behind this being, that angel investors are high net worth individuals that are always looking for investment opportunities, that helps startups in growing.

According to Section 56 (2) (viib) of the Income Tax Act, angel tax is the tax payable by privately held companies on the issue of shares at a rate higher than the fair market value. Usually, startups that do exponentially well issue their shares at a very high rate. The authorities proposed an amendment to the Act in 2012 to add this provision. The objective was to get a hold on money laundering activities, which were on a rise then. 

Angel tax exemption for startups

Out of all the different types of investors, only angel investors were levied hefty charges on their investment amount. Foreign investors or venture capital firms were not levied angel tax as per section 56 (2) (viib). On one hand, the Govt. reformed the DPIIT to promote ease of doing business in India. Whereas, on the other hand startups were subjected to hefty taxes on their success. As a result of which, the DPIIT introduced the Angel Tax Exemption in 2019 for recognised startups. Startups that get angel tax exemption certificate do not have to pay taxes on the angel investment received by them. 

Not all startups can claim this tax exemption. Only the following entity can apply for angel tax exemption in India: 

1. DPIIT recognised startups; 
2.  with an aggregate amount of paid-up share capital/premium less than INR 25 crores, after issue of shares, if any; and
3. has a fair market valuation reported by a certified merchant valuer. 

How to claim angel tax exemption? 

To claim startup tax exemption under section 56 (2)(viib) you need to follow the below-mentioned steps: 

Step 1: Create your startup India login

You need to visit the startup India portal, set up your profile, and get DPIIT recognition. You are only eligible for Startup tax exemption if you get your DPIIT recognition certificate. 

Step 2: Submit the form 

After getting DPIIT recognition, you need to fill out Form – 56. It is a “Declaration by a Startup for exemption under Section 56 (2) (viib) of the Income Tax Act, 1961. You need to provide the following information while filing this form: 

1. Name of the Startup; 
2. Date of incorporation;
3. Incorporation/Registration No.; 
4. Address of business; 
5. Nature of Business; 
6. Contact details (Phone no., e-mail ID, and PAN) of the startup; and 
7. Recognition number as provided by DPIIT; 

Step 3: Upload declaration form

A startup applying for the angel tax exemption needs to make a declaration to the authorities. In accordance with government-issued notice Dt. 19.02.2019, that they have not invested, and won’t invest in, any of the below-mentioned activities for 7 years: 

• residential house, other than that used by the Startup for its business purpose; 
• land or building, or both, other than that occupied by the Startup for its business; 
• loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is a substantial part of its business;
• a capital contribution to any other entity; 
• shares and securities; 
• a motor vehicle, aircraft, yacht, or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for plying, hiring, leasing, or as stock-in-trade, in the ordinary course of business; and
• jewellery other than that held by the Startup as stock-in-trade in the ordinary course of business.

This declaration form is supposed to be printed on the letterhead of the startup and duly signed by the authorised representative of the Company. 

Step 4: Assessment by an officer

An assessment officer is assigned to all applications made for the angel tax exemption under section 56 (2) (viib) of the Income Tax. This officer has to go through all the documents submitted by the startup and verify the information provided through the declaration. Thereafter, they may solely upon their discretion, pass an order or issue the certificate of tax exemption for startups. Even after the assessment, if it is found that the statements made in the declaration are untrue, the officer may even revoke their angel tax exemption certificate. 

Penalty for non – compliance with the rules of angel tax exemption

 If the startups applying for angel tax exemption fail to provide an honest statement of their income, i.e., under-report their income at any point, during the process, they will be liable to a penalty amounting to 200% of the amount of tax payable on the underrated income. Hence, even when you are applying for this tax exemption benefit for startups, you need to ensure accuracy. There’s an entire expert team of CAs at LegalWiz.in who can help you out by providing accurate information about your business. 

Other tax benefit for startups in India

Apart from the angel tax exemption, certain DPIIT recognised startups are also eligible to claim a 100% deduction in taxes for 3 consecutive years. This benefit is provided under section 80 IAC of the Income Tax Act. It is widely known as Section 80 IAC tax benefit for startups.

Conclusion

Till now, only the residential investors being high net-worth Individuals, i.e Angel Investors were a part of section 56 (2) (viib), namely ‘angel tax’. However, in the Finance Act, of 2023, there is a provision to bring non-resident investors of closely held unlisted companies within the ambit of angel tax. Hence, starting from the assessment year 2024-25, it is proposed that an angel tax will also be levied on investments by foreign individuals in Indian startups. This proposed provision also increases the need for the angel tax exemption benefit that is available to DPIIT-recognised startups in India. 

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