Angel tax abolished to boost India's startup ecosystem and innovation; experts hail decision 

The long-standing angel tax, described as "a major hurdle" by the startup ecosystem, has been abolished. "To bolster the Indian startup ecosystem, boost entrepreneurial spirit, and support innovation, I propose to abolish the so-called angel tax for all classes of investors," announced Finance Minister Nirmala Sitharaman during the union budget for 2024-25.

The angel tax, introduced in 2012 by then Finance Minister Pranab Mukherjee, was levied on funds raised by startups from angel investors when these funds exceeded the fair market value of the company, with a tax rate around 31% (30.9%). Intended to curb money laundering practices, the tax was criticized for stifling innovation and fundraising. Startups and investors alike felt relief with Sitharaman's announcement of its abolition.

Saurabh Srivastava, former Chairman of NASSCOM and co-founder of Indian Angel Network (IAN), argued that the introduction of the angel tax was a knee-jerk reaction to economic offenses and not a well-considered policy measure. He described it as a "lazy solution" that caused significant damage to startups. Srivastava, who was part of a government committee on creating a vibrant entrepreneurial ecosystem when the tax was introduced, mentioned how IAN tirelessly worked to have the tax revoked.

“I have lost count of the number of meetings at all levels of government that Padmaja (Padmaja Ruparel, co-founder of IAN) and I have attended over the years, and the various recommendations we put forward. But just when we were losing hope, the government has delivered,” Srivastava told Business Today.

Srivastava highlighted that abolishing the angel tax will transform the startup landscape, enabling explosive growth from 100,000 to a million startups over the next five years. With no financial barriers, both domestic and foreign investors will freely support Indian startups, leading to economic growth, massive employment, and solutions to challenges in healthcare, agriculture, education, and the environment.

In 2023, startup funding fell to $11.3 billion from $42 billion in FY 2022, as noted by India Accelerator, underscoring the need for reform. Eliminating the tax, which imposed up to 30% on investments, is expected to boost funding opportunities, rejuvenate investor confidence, and attract more investors. "The Sword of Damocles hanging has now come to an end," said Brijesh Damodaran, Partner at Auxano Capital, adding that this provides certainty to promoters and investors.

India's startup ecosystem, the third largest in the world, aims to become a $10 trillion economy by 2030. "The big step taken today will help us attain this goal," says Aparna Thyagrajan, co-founder of Shobitam, an Indian ethnic wear brand, and an angel investor who appeared on Indian Angels, one of the first angel investment shows on JioCinema.

Bhavik Vasa, founder and CEO of GetVantage, stated that the abolition of the angel tax will significantly benefit small and medium enterprises (SMEs) beyond startups. This development is expected to attract various forms of capital and financing, including equity and quasi-equity, to the high-growth segment. Manas Pal, co-founder of PedalStart, noted that by eliminating the angel tax, startups can retain more capital for growth and innovation, making Indian startups more attractive to investors and fostering a vibrant entrepreneurial environment.

While the startup ecosystem celebrated the abolition of the angel tax, Shubham Jhuria from Aeravti Ventures noted that five years ago, the tax was a significant issue. Angels and non-structured groups struggled to invest due to discrepancies between Fair Market Value (FMV) and agreed valuations. Though the abolition removes confusion and complexity, it doesn't significantly simplify investments in Indian startups. Combined with the increase in Long Term Capital Gains to 12.5%, this sends mixed signals about investing in the startup sector.

The angel tax was originally introduced to curb money laundering, as some individuals were engaging in fraudulent activities under the guise of investments. This measure was intended to combat the misuse of inflated valuations often associated with shell companies and bogus startups, which were exploiting loopholes to launder money. However, many startups found it challenging to justify their valuations, leading to significant tax liabilities that deterred investment.

Srivastava addressed money laundering concerns by stating that India already has sufficient laws to combat it. He emphasized that no other country imposes an angel tax, calling it a unique and ineffective solution that drove many top entrepreneurs to relocate to countries like Singapore, Dubai, and North America. He pointed out that tax revenues collected from startups since the introduction of the angel tax were minimal.

Thyagrajan added that over the past 10-12 years, the ecosystem has evolved significantly. While there were initial issues with money laundering, the startup ecosystem is now rapidly growing, and the positives far outweigh the negatives.