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Presentation on Angel Tax By Siddarth M Pai, Founding Partner, 3one4 Capital

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A presentation on Section 56(2)(viib) for the Inc42 AMA

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Presentation on Angel Tax By Siddarth M Pai, Founding Partner, 3one4 Capital

  1. 1. Angel Tax By Siddarth M Pai Founding Partner 3one4 Capital Section 56(2)(viib) or not (2)(viib) A presentation on Section 56(2)(viib) for the Inc42 AMA
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  4. 4. Section 56(2)(viib) • Taxes as income any capital receipt in “excess” of the Fair Market Value of the securities issued by a private company • Applies to share issued at a premium • FMV determined as the higher of: • Value as per DCF or NAV • As substantiated by the Co to the satisfaction of the tax officer • Only applies to Indian investors, not foreign investors – its not a tax on angels, it’s a tax on Indian investments! • Exemptions: SEBI registered VC Funds 4
  5. 5. Issues with the Section • High share premium is the outcome of valuation, not an indication of any “unaccounted funds” • Valuation methods being substituted during assessment proceedings
  6. 6. The Price of Premium Why attacking “high” share premium is missing the woods for the trees
  7. 7. The Price of Premium • All Valuation is driven this formula: Share Issue Price = Enterprise Valuation No of shares issued Share Issue Price = Face Value + Share Premium • A “high” premium can only be caused by the following: • Small share base • High enterprise valuation • Low face value A Typical Startup: • - Enterprise Valuation: Rs 10 Cr - Shares Issued: 10,000 - Face Value: Rs 10 Share Issue Price = Rs 10 Crore 10,000 shares = Rs 10,000 share “High” Share Premium: Rs 9,900 Face Value: Rs 10
  8. 8. Why is share premium being taxed when it’s the outcome of math, not money laundering?
  9. 9. Valuation Methods: Dealer’s Choice Substituting valuation methods is like measuring time in lightyears
  10. 10. Value of the Valuation Method • Method 1: Book Value • Method 2: Discounted Cash Flow Assets – Liabilities No. of Shares issued Image source – parsimo medium - Valuation for startups – 9 methods explained
  11. 11. Value of the Valuation Method • Financials upon Incorporation • Financials prior to funding: Round Details: Pre Money: Rs 9 Cr Investment: Rs 1 Cr Post Money: Rs 10Cr Dilution: 10% FV: Rs 10/share
  12. 12. Value of the Valuation Method FMV as per Book Value FMV as per DCF • Time period: 5 years • Terminal Growth Rate: 5% • Discount Rate: 25% Assets – Liabilities No. of Shares issued = 75,000 – 2,25,000 10,000 = negative Rs 15/share Issue Price: Rs 10,000 Face Value: Rs 10 Premium: Rs 9,900
  13. 13. Why are valuation methods being substituted and the difference liable to tax?
  14. 14. Fallout of Section 56(2)(viib) How this section has affected Indian startups
  15. 15. Indian startups have the lowest valuations worldwide! Silicon Valley Europe Israel India Source: Angellist - https://angel.co/valuations
  16. 16. Domestic early Investments decline while other investments rise Nasscom report – Indian Startup ecosystem Approaching Escape Velocity – Edition 2018
  17. 17. No of Early stage rounds is down 28.5% INVESTMENTS IN START-UPS BY ROUND Year Seed Series A Series B Series C Series D Series E+ 2014 91 145 56 28 11 10 2015 208 257 93 41 12 11 2016 198 186 102 45 20 11 2017 174 154 101 30 21 15 2018 148 137 83 62 24 15 Source: Venture Intelligence
  18. 18. No. of unique domestic investors down 48% since 2015 18 Inc 42 – State of the Indian Startup ecosystem - 2018
  19. 19. Circular Reference Impact of the latest DIPP circular on section 56(2)(viib)
  20. 20. New Circular on Section 56(2)(viib) What the Circular States • Won’t apply when the cumulative capital raise is below Rs 10Cr • Investors with an income > 50l & NW > 2Cr will have their investments exempt (accredited Investor) • Won’t apply to startups who have already received assessments orders What it should say: • Investments upto Rs 10Cr per year will be exempt as long as the PAN is provided • Accredited investor: • Threshold lowered to income >25 OR NW > 1Cr • Investment to be exempt along the lines of SEBI reg VC Funds • Any startup who has received an order can submit this during appeals
  21. 21. Next Steps and Helpful Links
  22. 22. Next Steps • Prepare a response to the assessment order passed & file it within the 30 day period • Attach the Startup India DIPP certificate with the above response (if you haven’t applied, please do at https://www.startupindia.gov.in/ • Attach a copy of the CBDT circular dated 24-12-18 - the no coercive measures stated implies that the CBDT will not attach the property or the bank accounts of the Company
  23. 23. How iSPIRT Can Help • Send a copy (redacted and original) of all notices and assessment orders on this issue to policy@ispirt.in Resources: • White paper on Angel Tax - https://pn.ispirt.in/white-paper-on-angel-tax-india/ • · Analysis of the cause of high share premia - https://pn.ispirt.in/white-paper-on- the-analysis-of-high-share-premium-amongst-startups-in-india/ • · Representation to the government on the matter - https://www.slideshare.net/ProductNation/angel-tax-presentation-to-dipp-section- 562viib
  24. 24. - Honourable Prime Minister Narendra Modi

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