The Indian government has announced the abolition of the contentious “angel tax” for all investor classes, marking a significant development for Indian startups. Finance Minister Nirmala Sitharaman made this announcement during her annual budget speech, aiming to bolster the Indian startup ecosystem and to support innovation.
Industry leaders have welcomed this move, with many calling it a game-changer. Padmaja Ruparel of Indian Angel Network Fund expressed gratitude to the Finance Minister for listening to startups and investors. Ninad Karpe of 100X.VC described it as one of the boldest moves, expecting it to boost the startup world significantly.
The angel tax, officially known as Section 56(2)(viib) of the Income Tax Act, was introduced in 2012 as an anti-abuse measure to prevent money laundering and round-tripping. It applied when a closely held company issued shares at a valuation higher than the fair market value, with the excess amount taxed at about 30% as income from other sources.
This tax had been a long-standing issue for the startup community, especially amid the recent funding slump. Venture capital investors argues that the tax hinders their “ease of doing business” as they often invest at higher valuations based on a startup’s future potential.
The 2023 Union Budget expanded the angel tax to include foreign investors, raising concerns among venture capital funds registered abroad. The amended rules aim to bridge the gap between the rules outlined in the Foreign Exchange Management Act (FEMA) and India’s Income Tax Act. India’s Central Board of Direct Taxes (CBDT) issued a circular exempting investors such as sovereign wealth funds and pension funds from 21 countries, including the U.S., UK and France, from the levy of angel tax for non-resident investment in unlisted Indian startups.
However, the list excluded investment from countries such as Singapore, Netherlands, and Mauritius, which account for heavy inflows into Indian startups. Venture capital investors registered in the non-exempted countries called the move counter-productive as foreign funding accounts for 75% of investments in Indian startups.
The abolition of the angel tax might accelerate the trend of “reverse flipping” – Indian startups relocating their domicile back to India. It’s also anticipated to foster innovation in India’s startup economy, currently the world’s third-largest.
In addition to the angel tax abolition, the budget announced other measures to support startups and the digital economy. These include a $100 million VC fund for the space economy and the withdrawal of the 2% equalization levy, which is expected to provide relief to digital companies.
Industry leaders such as Ghazal Alagh CIO and Founder of Honasa Consumer Limited praised the budget for its focus on digital transformation and AI integration, seeing it as a catalyst for growth and opportunities within the startup ecosystem.
The budget’s startup-friendly measures are seen as a balanced approach, covering employment, skilling, and infrastructure, which are expected to boost economic activity and aid in job creation.
* The India Angel Investing Fund also known as the IAN fund, facilitates growth and scale for innovative, high-potential startups through seed and early-stage investments. The IAN Fund portfolio currently comprises over 72 companies across domain sectors including healthcare and medical devices, VR, AI, software as a service, marketplaces, fin-tech, big data, artificial intelligence, and hardware.
