Angel tax is unwarranted

Entrepreneurial class and the venture capital industry alike are understandably disappointed that the government yet again let slip the opportunity presented by the Union Budget to do away with a piece of taxation that they regard as regressive. Dubbed the ‘Angel Tax’ on share premium paid to acquire new shares in a startup that the tax authorities call as ‘excessive’ continues to remain firmly entrenched in India’s tax code. 

Despite significant impact on funding, successive governments have shied away from rolling back the much-criticised tax out of political compulsions. The IT authorities demand additional taxes from startups who have received funding from Indian resident ‘angel investors’ at a valuation higher than what can be perceived for an early stage startup venture. Though it looks like a non-issue for others, at a time when businesses in the country would consider themselves to be fortunate to be able to garner any capital at all, the prospect of being able to issue shares at a premium far and beyond the business immediate and near-term profitability as to attract the taxman’s inquisitive enquiries must appear as laughable. 

Is not it ridiculous that some IT official thinks that the present value of all future cash flows in the business is less than the valuation arrived at and therefore seek to impose a tax on such perceived excess premium. This leads to ‘risk off’ of some badly needed incremental investment in a startup. A tax on invested capital is against all accepted notions of what constitutes a tax on income is beyond dispute. 

The government says it has modified the law to some extent to soften its impact, but these are more in the nature of some legal creativity when the substantive point of a tax on invested capital first introduced into the tax code in Budget 2012 remains very much in place. Angel tax has long remained an issue between the startup community and the government. However, the dispute became a fierce contest point recently with the tax terrorism launched by the Income Tax Department by sending more than 200 notices to startups in 2017 alone. 

The government’s defence is that black money hoarders, in conjunction with finance professionals and government officials, developed a practice wherein closely-held companies could bring in undisclosed money of promoters or directors or even third parties by issuing shares at a high premium, which is normally over and above the book value. Moreover, it argues, that in case of many closely-held companies, promoters would issue shares at a premium with the purpose of keeping share capital low, yet the capital base stronger, so that breakup value and market value is high. 

This, it says, leads to advantage of low cost of servicing share capital and also improved prospects to issue shares at a premium in future by way of initial issue of offering by promoters. The main controversy is in the concept of ‘fair value’. Startups work on presumptions and each valuation is done after rounds of negotiations, valuation reports, bankers’ reports, and several other regulatory compliance mechanisms. It is time the government shows a way out.