The entrepreneurial class and the venture capital industry alike are understandably disappointed that the Government has yet again let slip the opportunity of the presentation of the Union Budget (2018) to do away with a piece of taxation that they regard as regressive. Dubbed the ‘angel tax’, the tax on share premium paid to acquire new shares in a company that the tax authorities regard as excessive, continues to remain firmly entrenched in the country’s tax code.

For many, this may seem a non-issue. At a time when businesses in the country would consider themselves to be fortunate to be able to garner any capital at all, the prospect of being able to issue shares at a premium far and beyond the business’ immediate and near-term profitability as to attract the taxman’s inquisitive enquiries, must appear as laughable in the extreme. Nevertheless, the few that are fortunate enough to be able to do so must reckon with the reality of a tax penalty merely because some income tax official thinks that the present value of all future cash flows in the business is a lot less and therefore seeks to impose a tax on such perceived excess premium.

Against the grain

That a tax on invested capital is against all accepted notions of what constitutes a tax on income, is beyond dispute. But from a practical standpoint too, critics of the system have a point when they argue that there is a risk of choking off of some badly needed incremental investment in a startup enterprise.

Despite all the rhetoric and sound business logic implicit in a demand for doing away with ‘angel tax’, the offending piece of law is firmly entrenched in the tax code.

The Government has since modified the law to some extent to soften its impact. But these are more in the nature of some legal callisthenics when the substantive point of a tax on invested capital first introduced into the tax code with Budget 2012 remains very much in place.

In fairness to both the ruling BJP and the Congress, the principal opposition party, it must be said that they would dearly wish that ‘angel tax’ as a piece of taxation did not exist. But it doesn’t seem politically expedient for either of them to take the initiative for rolling it back.

To understand why this is so it would be necessary to look into the circumstances that led to the enactment of the ‘angel tax’ as part of the tax code.

It was politics pure and simple that drove it, and tax policy had nothing to do with it. At the time it was introduced in 2012 the general public was convinced that the entire administrative machinery of the Government was steeped in corruption.

This was after all the era of the Commonwealth Games scam, the 2G scam, the coal-block allotment scam and so on. Every facet of public policy had come to be clothed with the miasma of personal profit rather than genuine public interest.

More specifically, there was the case of an associate company of the beneficiary of 2G spectrum allotment subscribing to the shares at a huge premium in a company that clearly had links to the DMK, a party that was a member of the ruling United Progressive Alliance at the Centre.

What were the options?

Granted that it is hard to say if the two transactions (allotment of radio spectrum and a financial investment of a dubious nature) represented some kind of a quid pro quo . Harder still is it to establish criminality on the part of the minister responsible for allotting 2G radio spectrum within the framework of established principles of jurisprudence applicable to such cases.

But to a public inured to acts of self-aggrandising behaviour by elected representatives, none of this mattered. There was widespread revulsion at the actual turn of events that had come to light.

In the circumstances, what does the Government of the day do? It can stoutly defend the ministerial actions as driven solely by considerations of public interest, which of course it did since exemplified by the famous ‘zero loss’ theory.

But the presence of an investment transaction between a closely held company with ties to the ruling dispensation and an associate of the beneficiary of 2G spectrum allotment is an inconvenient intrusion into this ‘everything-is-pure-as-white-driven-snow’ kind of a narrative. It had, therefore, become necessary to be seen as penalising the recipient of some largesse that had accidentally materialised from an administrative decision.

The ‘angel tax’ has to be seen in this perspective. Thus it has become difficult for the Congress party to lead the charge for its abolition after having been responsible for its introduction. Equally, the BJP sees a roll-back of this tax provision as fraught with avoidable political risks. It is worth bearing in mind that the party was labelled a ‘suit-boot-ki-sarkar’ by none other than Rahul Gandhi.

It is a truism that when politics clashes with sound tax policy the former must inevitably prevail and ‘angel tax’ can be no exception.

The venture capital industry would do well to recognise that it is unrealistic to expect that the offending piece of taxation would altogether be abolished. What it can hope for and indeed must put forth with all the emphasis at its command is that the adverse cash flow consequences of the proposal be mitigated in some way.

Designing a system

As it happens, it is possible to design a system around the provisions of an ‘angel tax’ regime with none of the cash flow implication that such a tax entails:

• That excess share premium, such as it is, will be recognised as income.

• The resultant figure of tax will however not trigger any cash payout but instead will be merely recognised as a deferred tax liability in the books of the enterprise.

• The outstanding tax obligation may be permitted to be liquidated against actual fixed capital expenditure or incremental working capital needs through suitable accounting entries. The actual mechanics of such accounting adjustments need not engage us at this moment. Suffice to say, it is not exactly ‘rocket science’.

The larger point is this. It is possible to bring about tax reforms within the constraints of the political compulsions of those tasked with ushering in such changes. They just need to be shown a way around it.

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