Many tax laws in India seem to be framed on the premise that every citizen is guilty of tax evasion unless he proves otherwise. The angel tax provisions contained in Section 56(2) of the Income Tax Act fall squarely in this category. The levy is back in the news after scores of domestic start-ups have complained about tax notices in recent weeks. The Centre has now gone into damage-control mode, promising that angel tax demands would not be raised on genuine start-ups and coercive measures would be in abeyance, while an expert committee reviews these rules. But in a country that relies so heavily on its start-up ecosystem to innovate, create jobs and drive the next leg of economic growth, it is a moot question why a tax on angel investments must even exist in the first place.

Introduced in 2012 as an anti-money laundering provision, the section states that when any closely-held company issues shares to domestic investors at a price higher than its fair market value, the excess must be characterised as ‘other income’ and taxed at 30 per cent. Fair market value is to be determined only through book value or discounted cash flow methods, failing which the assessing officer must be ‘satisfied’ with it. There are serious flaws with this provision. One, treating the equity capital received by a business as income for tax purposes is plainly wrong, as accounting income arises only when the business uses this capital to create a product which yields a profit. Two, the valuation of a business is an issue best left to a venture and its investors. Expecting new-age start-ups to use textbook valuation methods and seek their assessing officer’s blessings every time they raise funds is draconian and opens the doors to misuse. Three, this tax on domestic investors gives home-grown start-ups every incentive to offshore their holding company and source capital through circuitous routes to subvert this rule. After a barrage of protests, the Centre moved to grant select start-ups exemption this April, but they are required to jump through multiple hoops. Even to apply to the inter-ministerial board for this exemption, a start-up is required to have less than ₹10 crore paid-up capital, the investor is required to have a minimum returned income of ₹25 lakh or net worth of ₹2 crore and the start-up needs to meet the DIPP’s definition of an innovative start-up. Given this battery of conditions, it is no surprise that only two start-ups have so far qualified.

Overall, the angel tax provisions make a mockery of this government’s thrust on Start Up India, Stand Up India and ease of doing business. It is ironic that while developed economies in the Euro zone and the US woo angel investors with tax rebates and capital gains tax exemptions, India should be tying such investors and the ventures they bet on, in swathes of red tape.

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