Angel tax changes will help start-ups combat funding winter, bring foreign capital: Experts

The amendments in the angel tax rules, announced by the Central Board of Direct Taxes (CBDT) on Friday, have received a thumbs-up from the Indian start-up stakeholders. Angel tax is the tax that has to be paid when an unlisted company issue shares to an investor at a price that is more than its fair market value (FMV).

Under the new provisions, investments by non-resident investors including central banks, multilateral entities, foreign pension and endowment funds, banks and insurers, foreign portfolio investors, and entities registered with market watchdog Securities and Exchange Board of India will be exempted from the ambit of angel tax. 

Karthik Reddy, Managing Partner, Blume Ventures & Chairperson at Indian Venture and Alternate Capital Association (IVCA) said that the proposed changes provide more clarity and flexibility to investors and start-ups. “The notification from CBDT and MF has been well received by the PE/VC industry as it provides more clarity to Indian startups and investors concerning section 56(2)(viib). The proposed norms aim to expand valuation methodologies and eliminate price differentials between resident and non-resident investors,” Reddy said. 

The provisions have also rolled out five more valuation methods which experts believe will provide start-ups the flexibility to assess their current financial situation and prospects better. 

Ashwani Singh, Managing Director and CIO of 35 North India Discovery Fund said that the five methods of valuation proposed by FinMin will lead to a more level-playing field. 

35 North India Discovery Fund is a SEBI-registered Alternative Investment Fund (AIF) that invests in high-growth companies. 

“The current CDBT rule 11UA allowed only book value and discounted cash flow (DCF) which were inadequate for start-ups as they neither had assets to look at book value nor sufficient cash flow for a duration to do a DCF. The addition of five new valuation methods takes care of this problem to reflect start-up values which are closer to reality and can be validated.”

Furthermore, another provision that stood out was Section 56(2)(vii)(b) of the Income Tax Act which did not allow variation on FMV previously. Now, up to 10 per cent, variation from the determined value is considered acceptable.

Experts also believe that these changes were much-needed, considering the somber mood within the ecosystem owing to the funding winter. According to a report by Tracxn Technologies, in the first quarter of calendar year 2023, Indian startups raised $2.8 billion which is a 75 per cent decline from the Q1 of 2022. The ecosystem stakeholders believe that the inflow of foreign capital, especially, in the current times is of paramount importance. 

Sudhanva Sundararaman, Senior Director at Deshpande Startups (which is an incubation center) says that start-ups need “additional capital options beyond domestic-based funds” to brave the storm of cash crunch. 

“The good part is that this development will attract a wider range of institutional investors to facilitate ongoing investments in the country,” Sundararaman told BT.

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