If you’re an entrepreneur, you’ve likely come across the term “Angel Tax.” Under Section 56(2)(viib) of the Income Tax Act, Indian startups were required to pay tax on certain investments. However, in the 2019 Union Budget, the government introduced some relief measures. To qualify for an angel tax exemption, startups must meet specific eligibility criteria.

This article provides insights into angel tax, exemptions, and other key details. Read on to learn more.

Budget 2024 Update:

The angel tax has been abolished for all investor categories starting from FY 2025-26 to boost India’s startup ecosystem.

What is Angel Tax?

Funding is essential for any early-stage business. Startups often seek investments in exchange for equity, as they lack physical assets to pledge as collateral. When a startup faces challenges in securing traditional funding, an angel investor may step in to provide capital.

The concept of angel tax is detailed in Section 56(2)(viib) of the Income Tax Act of 1961. Introduced by the Finance Act, 2012, this provision required unlisted startups (companies whose shares are not publicly traded) to pay tax if they received investments from angel investors above their Fair Market Value (FMV).

Any investment exceeding the FMV was considered “income from other sources” and taxed accordingly. However, as per the Union Budget 2024, angel tax will no longer apply from FY 2025-26, a move aimed at strengthening India’s startup landscape. Check out the Angel Tax Exemption – Eligibility, Declaration, and Application Process!

Example of Angel Tax Calculation

To better understand angel tax, consider the following scenario:

• A startup secures an investment of ₹15 crore from an angel investor.

   

• In exchange, the investor receives company shares.

   

• The FMV of the issued shares is ₹10 crore.

   

• The excess ₹5 crore (investment above FMV) is treated as taxable income.

   

• This excess amount was previously taxed at a rate of 30.9%.

   

Why Was Angel Tax Introduced?

The primary reason for introducing angel tax was to curb money laundering. In India, only 2% of the population adheres to tax regulations. Many startups fail to maintain proper accounting records or accurately report their assets, contributing to black money circulation.

To address this, the Income Tax Department introduced angel tax, ensuring that private companies were taxed on excessive share premiums received above FMV. However, with the abolition of angel tax in FY 2025-26, startups will now have a more conducive environment for growth and investment.

Drawbacks of Angel Tax

Here are some of the key disadvantages associated with angel tax:

• Angel tax applies only to startups funded by resident Indian investors.

   

• Startups receiving investments from venture capital firms or non-resident investors are not eligible for angel tax deductions.

   

• Startups often lose a substantial portion of their investment due to the tax, which can be a significant financial burden, especially in the early stages.

Angel Tax Exemption

As mentioned earlier, angel tax forces startups to forfeit a significant portion of their funding. Most startups, particularly in their initial phase, cannot afford such financial setbacks. The introduction of this tax faced widespread criticism from investors, entrepreneurs, and industry experts.

After continuous appeals from startups, the Indian Government introduced relaxations in the 2019 Union Budget. It was announced that startups registered under the DPIIT (Department for Promotion of Industry and Internal Trade) would be exempt from angel tax.

However, to obtain this DPIIT exemption, startups must submit an application along with the necessary documents to the Central Board of Direct Taxes (CBDT). Upon CBDT approval, the startup becomes exempt from angel tax.

Eligibility Criteria for Angel Tax Exemption

To qualify for an angel tax exemption, startups must meet certain requirements:

• The total paid-up capital and share premium after issuing shares must not exceed ₹25 crore.

   

• According to Rule 11 UA (2)(b) of the Income Tax Act of 1961, a merchant banker must evaluate the startup’s Fair Market Value (FMV).

   

• Investments from venture capital firms, non-resident investors (NRIs), and select other entities are not included in the taxable calculation.

   

• The startup’s annual turnover must not exceed ₹100 crore in any of the past fiscal years.

   

• Angel investors are eligible for 100% tax exemption on investments in startups with a higher FMV. However, they must meet the following criteria:

   

  • Their average annual income should not exceed ₹25 lakh.

     

  • They must have a net worth of at least ₹2 crore over the last three fiscal years.

     

• Startups can avail of a tax holiday for three consecutive years from the date of incorporation, during which they are exempt from paying income tax.

   

Government’s Decision to Abolish Angel Tax

The Indian Government has officially abolished angel tax for all investor categories starting from FY 2025-26. Finance Minister Nirmala Sitharaman stated that this move aims to strengthen India’s startup ecosystem, encourage entrepreneurship, and foster innovation.

Angel Tax Rate in India

India follows a structured taxation system that incorporates both proportional and progressive tax rates, depending on income and various other criteria. Angel tax was imposed at a steep rate of 30.9% on investments received by startups above their Fair Market Value (FMV). Startups securing funding from investors were required to pay this tax to the Income Tax Department.

Angel Tax Example

Angel tax created significant challenges for startups, as a substantial portion of their investment was lost due to taxation. Let’s illustrate this with an example:

Imagine a startup raises ₹50 crore by issuing 1 lakh shares to an Indian investor at a price of ₹5,000 per share. However, the fair market value of each share is only ₹2,000, making the total FMV of shares ₹20 crore.

Since the investment received exceeds the FMV by ₹30 crore (₹50 crore – ₹20 crore), the startup would have to pay angel tax on this excess amount.

• Excess amount taxed: ₹30 crore

   

• Angel tax rate: 30.9%

   

• Total tax payable: ₹9.27 crore

   

Final Thoughts

Despite tax exemptions introduced for startups and investors, angel tax remained a controversial issue. Many argued that it hindered startup growth by making it harder for new businesses to secure funding.

With the abolition of angel tax effective from FY 2025-26, this move is expected to streamline the funding process, boost investor confidence, and strengthen India’s startup ecosystem.