High net-worth individuals have a greater incentive to invest in Indian startups now
- On May 24th, the
Central Board of Direct Taxesgranted angel investorsa complete tax exemption on their equity investments in small startups.
- Until now, a tax of 30% was levied on the amount that the shares issued by startups to investors exceeded their fair value.
- The ruling is expected to encourage high-net-worth individuals and give a significant boost to the startup funding landscape in India.
AdvertisementA ruling by India’s Central Board of Direct
Until now, a tax of 30% was levied on the the value of shares issued above their fair value, by startups to investors, based on the budget released by former finance minister Pranab Mukherjee in 2012. This was done to prevent money laundering and selling of shares at a higher value than they were worth for the purpose of bribery.
However, this discouraged angel investors from buying shares at a premium, unlike venture capital funds and foreign investors, which benefited from a tax exemption for the same transaction. The premium received by these startups from angel investors for their equity was oddly classified as “income from other sources” and taxed accordingly. Hence, a lot of startups weren’t able to get the funding they needed in order to grow and compete for investments from VCs.
As a result of the ruling, angel investors will be given the same treatment, for tax purposes, as venture capital funds. This is expected to incentivise high-net-worth individuals and give a significant boost to the startup funding landscape in India.
The major issue of contention here related to the “fair value” of a startup - which fails to take into account intangible assets like goodwill or brand buzz - leaving them vulnerable to higher taxes on their angel investments if authorities feel the investment is well above what their valuation should be. If startups aren’t incentivised to sell their shares at a price above their fair value, their valuation will remain the same, regardless of their progress.
The CBDT’s notification also included a change in the entity responsible for assessing the fair value of startups. From now on, only merchant banks, as opposed to chartered accountants, are allowed to determine the value of an enterprise.
There are some conditions to the tax exemption, however. Firstly, it only applies to startups with a paid-up capital of ₹100 million or less following the share issue. So this covers the bulk of early-stage startups, which still bodes well for India’s startup ecosystem. Secondly, to qualify as an “angel investor”, an individual needs to have a minimum net worth of ₹20 million or an average income of ₹2.5 million in the previous three years.
Thirdly, the startup will have to procure a certificate indicating the fair value of the shares from a merchant banker.
AdvertisementWhile the cost of obtaining the certificate from a merchant banker is definitely higher than getting a chartered accountant to sign off on a startup’s fair value, the greater flow of financing will likely make up for this.
Popular on BI
- Elizabeth Holmes ordered dinners for Theranos staff but made sure they weren't delivered until after 8 p.m. so they worked late: book
- The CEO of software giant Intuit, which has avoided mass layoffs, says tech firms axed jobs because they misread the pandemic
- I flew cross-country with my 5-month-old son on my lap. Next time, I'm paying full price for him to have his own seat.
- Major train accidents that India witnessed in last 15 years
- Odisha rail crash: Rescuers try to raise buried coach, death toll at 238
- Largest road networks in the world – India beats China to take the second spot
- Manoj Bajpayee joins the league of on-screen lawyers like Pankaj Tripathi, Shriya Pilgaonkar & more
- List of famous things to buy in Lonavala