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Tag: angel tax exemption for startups

Tax Exemption for Startups in India | Section 80-IAC, 54GB, 56 2(VII B) Explained

Posted on by Treelife

Startups in India are experiencing rapid growth, fueled by individuals with unique ideas eager to address high-demand services. The Government of India has, through its Startup India Action Plan launched in 2016, implemented clear regulations to streamline the process of incorporating startups in the country. Additionally, tax regulations have been introduced to foster the growth of companies for whom a heavy tax burden in the early-growth stage can prove challenging. It’s essential for startups to familiarize themselves with these government regulations, as they can greatly benefit during income tax filing in India.

India offers a variety of appealing tax benefits aimed at encouraging and supporting startups. These benefits can substantially alleviate financial burdens, allowing startups to concentrate on their growth and innovation. Ranging from complete tax exemption for the initial 3 years to the recent 2024 abolishment of the angel tax, these incentives play a crucial role in promoting the financial stability and expansion of emerging businesses. The government consistently endeavors to provide tax benefits to entrepreneurs, particularly startups, recognizing their significant potential contribution to the Indian economy. This blog comprehensively deals with the intricacies of tax exemptions enumerated in contemporary legislations in India.

What is a Startup?

A startup is a fledgling business venture established with the aim of offering a single product or service deemed to be in demand by its founders. However, for the purpose of determining legal eligibility for taxation and to access government benefits, startups must meet the specific criteria set out in the Ministry of Commerce and Industry Gazette Notification No. G.S.R. 127(E) dated 19 February 2019 (“Startup Notification”). As outlined therein, an entity is recognised as a startup upon satisfaction of the following requirements:

  • The entity’s age must be under 10 years, indicating that it has been in operation for less than a decade from its date of incorporation or registration.
  • The entity must be registered as either a private limited company, limited liability partnership, or partnership firm to avail of startup-related advantages.
  • Its annual turnover for any financial year since its incorporation/registration should not exceed ₹100 crores.
  • The entity should actively engage in the innovation, development or improvement of products, processes or services; or if it is a scalable business, should have a high potential of employment generation or wealth creation.
  • The entity must not be established through the reconstruction or division of an existing business. 

Once determined that an entity satisfies the relevant criteria above, an application is required to be made to the Department for Promotion of Industry and Internal Trade (“DPIIT”) to obtain recognition as a startup (“Eligible Startup”). It is crucial to note that if an entity completes 10 years from the date of its incorporation/registration or if the turnover in any previous year exceeds ₹100 crores, the entity will no longer be considered an Eligible Startup. 

Tax Exemptions for Startups in India

Tax exemptions for startups are a constantly evolving regulatory space in India. Once recognised as an Eligible Startup, the Startup Notification further prescribes the processes to be followed to avail certain tax exemptions under the Income Tax Act, 1961 (“IT Act”). For example, Eligible Startups could apply for and avail angel tax exemption under Section 56(2)(viib) of the IT Act until the angel tax itself was abolished in 2024. This evolution speaks to the government’s initiative to encourage entrepreneurship and foster the growth of new businesses under the Startup India Action Plan.

In India, a startup can avail the following tax exemptions:

Income Tax Exemption for the Initial Three Years

Eligible Startups can avail of a three-year income tax holiday under Section 80-IAC of the IT Act, which exempts them from paying income tax on profits for any 3 consecutive years out of their first 10 years from the year of incorporation. However, this is subject to certain further conditions:

  • Business Type: The startup must be a limited liability partnership or a private limited company;
  • Incorporation Date: The company or LLP must be incorporated between April 1, 2016, and April 1, 2025. We have seen past instances wherein the deadline for this sunset clause keeps extending with every budget; and
  • Capacity Focus: The products, services or processes are undifferentiated, have potential for commercialisation and have significant incremental value for customers or workflow.
  • Tax Calculation: When calculating the deduction under Section 80-IAC, only the profits from the eligible business (i.e., business carried out by an eligible startup engaged in innovation, development or improvement of products or processes or services, or a scalable business model with a high potential of employment generation or wealth creation) will be considered.
  • Eligible Business Certificate: A certificate confirming the business as “eligible” issued by the Inter-Ministerial Board of Certification (IMBC) is necessary. This certificate will be published in the official government gazette.

Tax Exemption on Investment in Startups

Section 54GB has been amended to exempt tax on capital gains arising from sale of residential house or plot of land, if the net consideration amount is invested in prescribed stake of equity shares of eligible startups/companies to utilize the same for purchase of specified assets.

  • Eligibility of Assessee: This exemption can be availed by Hindu Undivided Families or individuals. 
  • Eligibility of Investee Company: The company is required to: (i) be incorporated in India; (ii) engaged in the business of manufacture of an article or thing or in an eligible business; (iii) ensure the assessee has more than 50% of the share capital/voting rights after subscription; (iv) be a small or medium enterprise or is an eligible startup.
  • Timelines: The assessee claiming the exemption is required to subscribe to the equity shares before the due date for furnishing return of income; and the company has to utilize the subscription amount for purchase of an asset within 1 year from such subscription date. The assessee claiming exemption shall be required to hold onto the shares for a period of 5 years.

Tax Exemption on Long Term Capital Gains

There is a separate provision for startups and capital gains reinvestment under Section 54EE. This section allows any taxpayer  to claim exemption from tax on long-term capital gains (from any asset, not just residential property) if they reinvest the gains in a fund notified by the Central Government within 6 months from the sale. The government offers a tax break on long-term capital gains through Section 54EE of the IT Act. Following are the key requirements of for exemption under 54EE:

  • Eligibility: All assessees may avail of this exemption if they invest in a specified fund notified by the Government. However, no such funds have been notified as on date.
  • Tax Exemption: Startups can claim exemption on long-term capital gains from any asset (not just residential property).
  • Investment Requirement: To be eligible for the exemption, capital gains from selling an asset must be reinvested in a government-approved fund within 6 months.
  • Investment Limit: There’s a cap on the exempt amount – a maximum of ₹50 lakh can be invested.
  • Holding Period: The funds must be held for at least 3 years. Early withdrawal cancels the exemption.

Tax Exemption for Eligible Incubators and Venture Capital Funds/Venture Capital Companies

Incubators recognized by the Government of India and registered Venture Capital Funds and Venture Capital Companies are eligible for tax exemptions on their income under Section 10(23FB) of the IT Act. The prescribed eligibility criteria for the exemption u/s 10(23FB) is expansive and involves stringent regulation through the Securities and Exchange Board of India (SEBI). This can include requirements that the entity cannot list their own shares on any public exchange and/or investment of at least two-thirds of its investible funds in unlisted equity-linked securities. Such VCF or VCC may also be subject to investment restrictions on sectors or asset classes, in accordance with the applicable regulations.

Conclusion

Conclusively, the tax exemption for startups in India serves as a vital catalyst for fostering innovation, entrepreneurship, and economic growth. By providing relief from certain tax burdens during the initial years of operation, the government encourages the emergence of new ventures, thereby stimulating job creation and technological advancement. However, it’s imperative for policymakers to continually evaluate and refine these provisions to ensure their effectiveness in nurturing a vibrant startup ecosystem. Overall, the tax exemptions for startups stand as a pivotal measure in propelling India towards becoming a global hub for innovation and entrepreneurship.

FAQs on Tax Exemptions for Startups in India

  1. What is considered a startup for tax exemption purposes in India?
    A startup is defined as an entity that:
    Has been in operation for less than 10 years from its incorporation or registration date.
    Is registered as a private limited company, limited liability partnership, or partnership firm.
    Has an annual turnover not exceeding ₹100 crores for any financial year since incorporation.
    Engages in innovation, development, or improvement of products or services, or operates a scalable business model with high potential for job creation and wealth generation.
  2. What are the key tax benefits available for startups in India?
    Startups can avail:
    A three-year income tax holiday under Section 80-IAC.
    Exemption on capital gains reinvestment under Sections 54GB and 54EE.
    Tax exemptions for eligible incubators and venture capital funds under Section 10(23FB).
  3. How does a startup qualify for the income tax holiday under Section 80-IAC?
    To qualify, the startup must:
    Be a private limited company or an LLP.
    Have been incorporated between April 1, 2016, and April 1, 2025.
    Obtain certification from the Inter-Ministerial Board of Certification (IMBC).
  4. What conditions must be met for the capital gains tax exemption under Section 54GB?
    Individuals or Hindu Undivided Families (HUFs) can claim this exemption if:
    The net consideration from the sale of a residential house or plot is invested in the equity shares of an eligible startup.
    The startup must use the funds to purchase assets within one year of the investment.
    The investor must hold the shares for at least 5 years.
  5. Are there any limitations to claiming the long-term capital gains exemption under Section 54EE?
    Yes, the key conditions include:
    The exemption is capped at ₹50 lakh.
    The reinvestment must be made in a government-notified fund within 6 months of the asset sale.
    The investment must be held for at least 3 years to maintain the exemption.
  6. Can all startups claim tax benefits under the Income Tax Act?
    No, only startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) as Eligible Startups can claim these benefits. Startups must meet specific criteria outlined in the Startup Notification and obtain necessary certification.
  7. What happens if the turnover exceeds ₹100 crores or the startup completes 10 years?
    If a startup’s turnover exceeds ₹100 crores or it completes 10 years from the incorporation date, it will no longer be considered an Eligible Startup and will not qualify for the related tax exemptions.
  8. What are the tax exemptions for venture capital funds and incubators?
    Registered venture capital funds and recognized incubators can claim tax exemptions on their income under Section 10(23FB), provided they meet stringent eligibility criteria set by the SEBI. 

Angel Tax Exemption – Eligibility, Declaration, How to Apply

Posted on by Treelife

India’s startup landscape has become an ongoing global success story, attracting a swarm of investors eager to tap into its potential. From angel investors to venture capitalists, everyone’s looking for the next big thing. But there’s a hidden hurdle for young companies: the angel tax.

Angel tax was introduced in the Finance Act, 2012 and came into force post-April 2013. It requires startups to pay taxes on the difference between the investment amount they receive and the fair market value determined by the government.  The difference between the issue price of the shares and the FMV as determined by the tax authorities is treated as income from other sources and taxed at the prevailing income tax rate. This can be a significant financial burden for startups, especially those in their early stages. Determining a fair market value for a budding startup is notoriously difficult. While the government introduced some exemptions in the Union Budget of 2019, strict conditions apply. This has created a situation where a well-intended tax regulation aimed at curbing money laundering has unintentionally become a roadblock for many legitimate startups.

In this article, we will understand the intricacies of angel tax, the exemptions allowed under India’s tax regime, and the potential reasons behind angel tax becoming a breakthrough in the fast-paced entrepreneurial spirit of our country. 

What is Angel Tax?

The angel tax, introduced by Section 56(2)(viib) of the Income Tax Act, 1961, applies to unlisted companies (startups whose shares aren’t publicly traded) that receive funding exceeding the Fair Market Value (hereinafter ‘FMV’) determined by the government. This excess investment is considered “income from other sources” and is taxed at a rate of 30.9% (inclusive of a 30% income tax rate and 3% cess). Section 56(2)(viib) of the Income Tax Act 1961 encompasses a provision that pertains to closely-held companies issuing shares to resident investors at a value exceeding the “fair market value” of those shares. In such cases, the surplus amount of the issue price over the fair value is subject to taxation as the income of the company issuing the shares. Hence, angel tax is a built-up concept inculcated in the Finance Act, 2012 over the foundational block of provisions of the Income Tax Act, 1961. 

The core issue lies in determining a startup’s FMV. Unlike established companies with a track record, startups are young and often lack a readily available market value. This makes the government’s FMV assessment subjective and potentially inaccurate. Imagine a scenario where an investor believes your innovative idea has immense potential and offers ₹15 crore for shares whose FMV is estimated at ₹10 crore by the government. Under the angel tax, that ₹5 crore difference would be taxed, creating a significant financial burden on an early-stage company.

Which investment falls under the angel tax category?

Any funding a startup receives from an investor, if it exceeds the FMV determined by the government, falls under the angel tax category. This can include investments from angel investors, individuals who provide early-stage capital, or even venture capitalists if the startup is still unlisted. The key factor is the difference between the investment amount and the government’s FMV assessment, not the specific type of investor.

What is an Angel Tax Exemption?

The Indian government has introduced exemptions to the angel tax. The new policy exempts startups registered under the Department for Promotion of Industry and Internal Trade (DPIIT) from the angel tax. 

The primary route to tax benefits lies in obtaining recognition from the Department for Promotion of Industry and Internal Trade (DPIIT). This involves submitting an application along with supporting documents to the Central Board of Direct Taxes (CBDT). Once approved, your startup can breathe a sigh of relief and be shielded from the angel tax.

Eligibility Criteria for Angel Tax Exemption:

In order to get an exemption, the government has laid down eligibility criteria for angel tax exemption in a two-fold structure. A startup has to be first recognized and registered as prescribed under G.S.R. notification 127 (E) are eligible to apply for recognition under the program. The two-fold structure includes: 

  1. Eligibility Criteria for Startup Recognition
  2. Eligibility Criteria for Tax Exemption under Section 56 of the Income Tax Act, 1961

Eligibility Criteria for Startup Recognition (DPIIT)

While DPIIT (Department for Promotion of Industry and Internal Trade)  recognition for a startup unlocks the exemption door, there are specific criteria a startup needs to fulfill:

  • The company must be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership.
  • The company’s turnover should not exceed INR 100 Crore in any of the previous financial years.
  • A company shall be considered as a startup up to 10 years from the date of its incorporation.
  • The company should demonstrate a focus on innovation or improvement of existing products, services, or processes. Additionally, it should have the potential for job creation or wealth generation.
  • Companies formed by splitting up or restructuring an existing business are not eligible for this recognition.

Eligibility Criteria for Tax Exemption under Section 56 of the Income Tax Act, 1961

After getting recognition, a startup may apply for an angel tax exemption. The eligibility criteria are as follows:

  • The startup must be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT).
  • The aggregate amount of the startup’s paid-up share capital and share premium (the additional amount paid by investors over the face value of the shares) cannot exceed INR 25 Crore after the proposed investment. However, the calculation of the paid-up capital shall not include the consideration received in respect of shares issued to a non-resident, a venture capital fund, and a venture capital company.

What is the Angel Tax Exemption Declaration?

Angel tax declaration is a formal statement submitted alongside your exemption application. It serves as a commitment from your startup to adhere to specific investment restrictions for a set period. The declaration outlines several asset categories where your startup cannot invest for a period of seven years following the end of the financial year when the shares are issued. These restrictions aim to ensure that the funds raised are used for core business purposes and not for personal gains. Here’s a breakdown of the restricted asset categories:

  • Residential Property: Investments in residential houses (except those used for business purposes or held as stock-in-trade) are prohibited.
  • Non-Business Land and Buildings: Land or buildings not directly used for business operations, renting, or held as stock-in-trade cannot be purchased.
  • Non-Business Loans: Loans and advances outside the ordinary course of your business are restricted (unless lending money is your core business).
  • Capital Contributions: Investing in other entities is not permitted.
  • Shares and Securities: Investments in other companies’ shares or securities are off-limits.
  • Luxury Vehicles: Vehicles exceeding ₹10 lakh in value (except those used for business purposes) cannot be purchased.
  • Non-Business Assets: Investments in jewelry (outside of stock-in-trade), art collections, or bullion are prohibited.

The angel tax exemption declaration is a critical component of securing relief from the angel tax. By submitting this declaration, your startup demonstrates its commitment to responsible use of the raised funds, fostering trust with the government and investors.

Download the Angel Tax Declaration template here 

(Please ensure that the declaration is on the letterhead of the company.)

How to apply for angel tax exemption?

Recognizing the complexities involved, the government has taken steps to simplify the process. Now, DPIIT-recognized startups can directly apply for angel tax exemption with the Department of Industrial Policy & Promotion (DIPP). 

  • Login to https://www.startupindia.gov.in/  and insert your login credentials.
  • Click on the ‘Dashboard’ tab and then, click on ‘DPIIT RECOGNITION’.
  • Scroll down the page and come to Form 56 – then click on ‘Click Here To Apply Form 56’.
  • Once the form opens, all details but: (i) point 9 (where you have to upload a signed declaration); and (ii) point 10 (declaration signing date), will be pre-filled, based on the information provided at the time of filing the Startup India registration.
  • Please ensure that the signed angel tax exemption declaration has complete and accurate details and that the declaration is on the company’s letterhead.
  • Upload the signed declaration in .pdf format and insert the date of signing of the declaration. Once done, click on ‘Submit’.

angel tax exemption

DIPP will then forward your application to CBDT, who are mandated to respond (approval or rejection) within 45 days of receipt. As a confirmation of the company having received the angel-tax exemption, the startup will receive an email from CBDT at the email ID submitted on the Startup India portal, within 1-3 weeks from the date of filing the application.

Benefits of Angel Tax Exemption 

The angel tax exemption in India offers a breath of fresh air for both startups and angel investors. Here’s a breakdown of the key advantages:

  • Reduced Financial Burden: Exemption eliminates the hefty 30.9% tax on excess investment, allowing startups to retain more capital for growth.
  • Easier Access to Funding: Reduced tax liability attracts more angel investors, widening funding options for startups, especially in their crucial early stages.
  • Focus on Growth: Saved funds can be directed towards vital areas like product development, marketing, and team expansion, accelerating growth and innovation.

Disadvantages of Angel Tax for Startups in India

The angel tax, while intended to curb money laundering, has several drawbacks that hinder the growth of startups in India. Here’s a breakdown of its key issues:

  1. Valuation Discrepancies: Unlike established companies, startups are valued based on future potential. This makes determining a fair market value (FMV) subjective. SUbsequently taxing at a high rate (30.9%), potentially depleting crucial startup capital.
  2. Discouraging Investment: The hefty angel tax rate discourages potential angel investors to fund promising startups due to the fear of a substantial tax bill, hindering the flow of essential funding for young companies.
  3. Unequal Access to Capital: The angel tax initially only applies to investments from resident Indians. However, the updated regime includes the applicability of the exemption to foreign investors as well. Besides, no explicit inclusion of Non-Resident Indians (NRIs) is mentioned. Startups receiving funding from venture capitalists or Non-Resident Indians (NRIs) are exempt. This creates an uneven playing field, potentially limiting access to diverse funding sources for some companies.
  4. Stifled Growth: A hefty angel tax bill can significantly impact a startup’s growth trajectory. Funds are diverted away from critical areas like product development, marketing, and hiring, hindering innovation and market competitiveness.

Angel Tax Example for Indian Startups

Imagine your startup’s revolutionary new app catches the eye of an angel investor who offers a substantial ₹15 crore for shares. While this sounds like a dream come true, the Indian government might have a different take. If they value those shares at a lower ₹10 crore, the difference (₹5 crore) is considered excess investment and taxed a hefty 30.9% under the angel tax. This unexpected ₹1.54 crore tax bill can significantly impact funding, making the angel’s investment a double-edged sword for your young companies. However, if a startup is recognized and registered under the requisites of angel tax exemption, i.e., DPIIT startup recognition, it benefits from the significant tax liability that would otherwise be incurred on investments received at valuations higher than fair market value. 

Conclusion

The angel tax in India, while initially intended to curb money laundering, has become a double-edged sword for startups. The high tax rate on investments exceeding the government’s Fair Market Value (FMV) assessment can significantly deplete crucial funding. However, the introduction of exemptions for DPIIT-registered startups offers a ray of hope. This exemption not only reduces the financial burden on startups but also fosters a more vibrant angel investor ecosystem by providing tax benefits to qualified investors. While some complexities remain in the application process, navigating them with the help of tax advisors can unlock the true potential of the exemption. Ultimately, striking a balance between encouraging legitimate investment and upholding tax regulations is key to fostering India’s burgeoning startup scene.



Frequently Asked Questions (FAQs) for Angel Tax and its Exemption

Q: What is the angel tax?

The angel tax applies a levy on startups that receive investments exceeding the Fair Market Value (FMV) determined by the government. This difference between the investment amount and FMV is taxed at a rate of 30.9%.

Q: When was the angel tax introduced?

The angel tax emerged in India with the Finance Act of 2012, aiming to curb money laundering through inflated startup valuations. Inflated valuations of startups were seen as a potential channel for black money.

Q: How does the angel tax impact startups?

The high tax rate on the FMV difference discourages potential angel investors and depletes crucial funding for startup growth.

Q: What are the benefits of angel tax exemption?

Exemption from the angel tax reduces the financial burden on startups, allowing them easier access to funding and a sharper focus on core business activities.

Q: How can a startup get exempt?

DPIIT registration and an application to the CBDT for exemption are required.

Q: What are the eligibility criteria for exemption?

  • DPIIT registration
  • Capitalization under Rs. 25 crore
  • Investment from specific sources (not all trigger the tax)
  • Annual turnover below Rs. 100 crore

Q: What does the angel tax exemption declaration entail?

The declaration is a commitment from the startup to refrain from investing in certain assets (luxury vehicles, real estate) for a period of seven years following the investment.

Q: How has the angel tax policy changed?

The 2019 Union Budget introduced exemptions, and ongoing reforms aim to create a more balanced approach.

Q: What are the challenges with angel tax benefits?

The application process can be complex, and FMV assessment can be subjective. Consulting tax advisors is highly recommended.

Q: What’s the future of the angel tax?

Reforms are expected to simplify the process and encourage a more vibrant angel investor ecosystem for India’s booming startup scene.

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