Intro
India is home to the world’s 3rd largest startup ecosystem and has produced some of the most successful unicorns in industries ranging from ed-tech to construction. Over the past decade, Indian startups have attracted significant investment from foreign venture capitalists, including Sequoia and Tiger. However, there are concerns that this surge in investment may be leading to a new bubble, prompting the Indian government to reintroduce the Angel Tax in 2023 to prevent its formation.
The History
This is not the first time that Angel Tax has been imposed on companies in India. The tax was initially announced in 2012 when the Indian startup ecosystem was not as extensive, and it served as a measure to prevent money laundering. However, as India’s startup ecosystem, along with the rest of Asia, continued to grow, the government wanted to foster further expansion and thus abolished the tax in 2019 to attract foreign investors.
What is the Angel Tax?
Firstly, it’s important to note that this tax is applicable only to companies that meet the Indian government’s definition of a ‘startup’, which includes being registered under one of the three company acts, being less than seven years old, and having a turnover of less than 25 crore rupees ($3.4 million). Furthermore, the calculation of this tax differs somewhat from angel taxes in other parts of the world.
To determine the levy amount, the government compares the fair market value, which is calculated using a NAV model (simply deducting assets from liabilities), with the valuation provided by the angel investor. Let’s consider the example of Company K: suppose an angel investor values the company at $100,000 and invests $10,000 for a 10% stake, but the Indian Revenue Service (IRS) values the company at $50,000 and considers the investment to be worth only $5,000. In this case, the company would have to pay a 30.9% tax rate on the additional $5,000, as it would be classified as ‘other income’.
Exemptions
Many companies are able to avoid this tax by not meeting the criteria for classification as a ‘startup’ outlined above. This means that foreign registered startups and those older than seven years do not face this tax. Additionally, the tax can be avoided if the investment value is below 25 crore rupees ($3.4 million) or if the net worth of the investor falls below a certain level. Therefore, smaller local investors are spared from this tax.
Effects and Issues
This measure primarily targets major foreign venture capitalists such as Sequoia and Accel, aiming to prevent excessive capital from flooding the market and creating a bubble. However, the timing of this tax has received significant criticism as the Indian startup ecosystem has been seeking foreign investors and has faced a scarcity of capital following the COVID-19 pandemic. Furthermore, the valuation methodologies employed by the IRS are subject to dispute as valuation is highly subjective. Using a static measure like NAV for startups is controversial, particularly considering that most startups are asset-light in nature. Models like NAV tend to give more value to startups with greater assets. Finally, this tax may potentially delay or even prevent early-stage companies that require substantial initial capital investment from generating revenue and profit as they are burdened with paying an angel tax even before commencing operations.
About the author
I write about stocks, investing, and banking. I am a student at Holland Park School.
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