The Budget 2024 presented by the Hon’ble Union Finance Minister of India marked a pivotal moment for the country’s startup ecosystem. One of the most notable announcements was the abolition of the controversial Angel Tax. This move has been widely celebrated by entrepreneurs and investors alike, as it is expected to significantly bolster the startup ecosystem, encourage innovation, and attract more investment into the country. This article explores the origins of the Angel Tax, the challenges it posed, and the anticipated impact of its abolition on India’s startup landscape.

What is Angel Tax?

Angel Tax was introduced in the Budget of 2012 under Section 56(2)(viib) of the Income Tax Act, 1961. The primary objective of this tax was to curb the practice of money laundering through startups. Wealthy individuals (HNIs) and other investors often invested in startups by purchasing shares at a price significantly higher than the Fair Market Value (FMV). This excess premium was then taxed as ‘Income from Other Sources’ at an effective rate of 30.9%. The tax became a significant burden for startups, which often struggled with cash flow during their early stages.

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Challenges Faced by Startups

The introduction of Angel Tax created several challenges for startups:

1. Lack of Clarity: The application of Angel Tax was not well understood, creating confusion among companies and tax professionals alike.
2. Valuation Issues: Determining the FMV of shares was problematic, and the methods prescribed for valuation often led to disputes between startups and tax authorities.
3. Cash Flow Constraints: Startups, already in their nascent stages, faced severe cash flow issues due to the tax, which could either be paid or dealt with by bribing tax authorities.
4. Discouragement of Investors: The heavy tax on excess premiums discouraged potential investors, leading to a reduction in the investment pool available to startups.
5. Diversion of Focus: The constant notices and orders from the Income Tax Department diverted startups' focus from innovation to resolving tax issues, leading to reduced productivity.
6. Global Disadvantage: These challenges put Indian startups at a disadvantage in the global market, where they had to compete with better-supported peers.

Judicial Clarifications

Several judicial pronouncements attempted to clarify the scope and application of the Angel Tax:

• Asstt. CIT v. Golden Line Studio (P.) Ltd. [2018]: The Mumbai ITAT clarified that the Angel Tax is to tax the premium amount paid on shares in exchange for ownership. (equity shares) and hence, preference shares would not be covered within the ambit of the provision.
• Asstt. CIT v. Subodh Menon [2019]: The ITAT ruled that the provisions of Section 56(2)(vii) were intended to prevent money laundering, not to tax bona fide business transactions.
• Cinestan Entertainment Pvt. Ltd. v. ITO [2019]: The Delhi ITAT held that the Assessing Officer could not reject an FMV valuation provided by a qualified expert using a prescribed method.

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Government Efforts to Ease the Burden

From 2016 to 2018, Angel Funds significantly dried up and the number came down by more than 40%. This created a havoc in the startup community. In response to the outcry from the startup community, the government introduced several measures to ease the burden of Angel Tax. The 2019 Union Budget introduced exemptions and tax benefits for startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT). This move led to a significant increase in the number of recognized startups, from 471 in 2016 to nearly 73,000 by mid-2022. Despite these efforts, the fundamental issues with Angel Tax persisted, leading to continued calls for its abolition.

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Abolition of Angel Tax in Budget 2024

The Union Government’s decision to abolish the Angel Tax in the 2024-25 Budget was a landmark move aimed at removing the hindrances faced by startups. The finance minister justified this decision by stating that existing laws, such as the Prevention of Money Laundering Act (PMLA) and the Black Money Act, were sufficient to address concerns related to money laundering. The abolition is expected to provide a significant boost to the startup ecosystem by creating a more favourable environment for innovation and investment.

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Impact on the Startup Ecosystem

The abolition of Angel Tax is anticipated to have several positive impacts on the startup ecosystem:

1. Increased Investment: With the removal of Angel Tax, investors may feel more encouraged to invest in startups, leading to a fresh inflow of capital into the economy.
2. Focus on Innovation: Startups can now focus more on innovation and growth rather than navigating complex tax issues.
3. Global Competitiveness: The abolition of Angel Tax is expected to improve the global competitiveness of Indian startups, making India a more attractive destination for entrepreneurs and investors.
4. Regulatory Clarity: While the abolition is a positive step, there are calls for further regulatory clarity to ensure that fraudulent startups do not exploit this benefit.

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The abolition of Angel Tax marks a new era for the Indian startup ecosystem. As India aims to become a $10 trillion economy by 2030, this move is expected to play a crucial role in achieving that goal. However, the government must continue to refine its policies to ensure that the startup environment remains conducive to growth and innovation. The results of this policy change will be closely watched, and it is hoped that it will lead to a flourishing startup ecosystem that can drive India’s economic growth in the coming years.

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