Taxation of Angel Investments


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A brief analysis of the proposed 30% taxation of > INR 5 Crores investment in private companies and its implications to the entrepreneur and angel ecosystem.

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  • Union Budget 2012 – 13 -
  • Taxation of Angel Investments

    1. 1. Under IFOS of Income Tax Act, 1961Clause Under Analysis : Sec 56 (2) (VIIb)B.Jayanth Kashyap (DF11008)Vishnu Palaniappan R. (DF11030)
    2. 2.  Angel Investors – Persons who provides financial support for startups or entrepreneurs. They are typically high networth individuals who fill the gap in the financing needs of the startups. Angels typically invest their own funds unlike Venture Capitalists who deploy external money. Investments are typically < $1 million (~INR 5 crores) Angel investors typically invest in companies that deal with sectors that personally interest them, and are often the first investors in a company.
    3. 3.  Where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund. Explanation. For the purposes of this clause,— (a) the fair market value of the shares shall be the value—(i) as may be determined in accordance with such method as may be prescribed; or(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on thevalue, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how,patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similarnature, whichever is higherIn short..The Budget has introduced a new clause which will treat all individual investments (whichwill include genuine angel money also) in a company as "income from other sources", andthey will be subject to a tax of 30% at the hands of the companies (including all genuinestartups).
    4. 4. - Serious ramifications for the entrepreneurial and angel ecosystem- It is estimated that 90% of start-ups fold up in the first two years of their inception for lack of funding support; this amendment will further hinder the availability of precious seed money for companies- Lack of a stable deal pipeline for VC and PE investments as the pool of angel backed companies is a feeder for the entire PE/VC industry- Job creation would be affected- For a small business, 30 per cent less money has a huge impact and it could mean six months to one year of cash flows- FMV has to be "substantiated" to the satisfaction of assessing officer who is not an expert on valuation of especially emerging businesses such as facebook, flipkart and Twitter. This may provide an opportunity to the AO to exploit the company hence leading to corruption- Valuing startups on the basis of intangibles (patents, trademarks, innovative concepts, goodwill, track record of founders etc.) cannot be justified or easily explained to the AO- Most importantly valuations will take a hit as startups will have to dilute more stake in return for less capital
    5. 5.  ‗Pre Angel Tax clause‘- Angel wants to invest Rs.1 crore for 20% stake in a company that has Rs.1 million (FV Rs.10 each) as paid up share capital- This would result in an issue price Rs.500 per share- Share issued to Angel – 20,000 shares- Company valuation – Rs.5 crores ‗Post Angel Tax clause‘- 30% of Investment amount above FMV to be paid as income tax- Funds Available to entrepreneur ~Rs.68.6 lakhs- New company valuation - ~Rs.3.4 crores
    6. 6. ―This clause will completely kill all angel investment in the country and with that, spell the death knellof first-generation entrepreneurship that had begun to mushroom over the last few years.Rather than giving the angel investor a tax break for making such risky investments for the commongood (creation of wealth and employment), as is done by most countries in the world, we are in effecttaxing them and, therefore, encouraging them to put their money in unproductive assets like farmhouses and real estate‖- Saurabh Srivastava, Co-founder, Indian Angel Network“The complication of the new budget has suddenly created a huge rush in the companies and theinvestor’s community. It definitely gets a little tricky as now we are debating between an angel or a VCround.If 30 per cent of the angel investment goes to taxes it might be hard to go with angel rounds especiallysince angels will probably want the same amount of stake and at the end of the day we will sell equityat a lower price.Angel funds come with a lot of mentorship and the funded companies can grow slower and in a moresustainable way understanding the business as they go - often times is a preferred way to build yourbusiness as compared to raising money from a VC”- Rajarshi Chattejee, Co-founder,
    7. 7.  Although the move has been implemented by the government to curb money-laundering and parking of funds by wealthy individuals in companies, it could kill the nascent entrepreneurial-startup ecosystem in India. Companies that receive less than Rs.5 crores individually and Rs.10 crore overall can be exempt from this bracket. (As suggested by members of the angel community and top consultants to the Finance Ministry) Given the current position of India, entrepreneurship is required to bolster the economy to new frontiers. As such, this new clause is a regressive step for such hopes and aspirations. It is hoped that the government would rather provide more tax breaks rather than breaking the backs of the ‗genuine‘ entrepreneurs.
    8. 8.  India Budget VCCircle (Alok Kejriwal) Novojuris Blog