India has one of the fastest-growing startup ecosystems in the world. And the recent government initiatives like Make in India, Startup India and schemes of small business loans are giving it a further boost.

Such business loan schemes and promotional campaigns are having a positive impact on angel investors in India and around the world who are increasingly investing in startups in India. An angel investor is a person who provides capital to startups in exchange for convertible debt or ownership for equity in the startup.

Until recently, startups in India had to face a big issue of Angel tax, which was introduced in 2012. Angel tax is the income tax levied on the capital raised by companies which are unlisted, through issuing of shares via off-market transactions.

The uniqueness about this tax is that it is levied if the angel investor is an Indian citizen. Along with that, the tax is applicable if the share price of issued shares is more than the company’s fair market value. The excess value is considered as income and deemed taxable.

Angel tax was introduced under the Finance Act, 2012 to combat money laundering through small companies. However, it was having a negative impact on the startup ecosystem.

To stop this negative impact on the startups in India, the government has given certain concessions like the entity will be deemed startup for 10 years up from 7 years. In addition to that, the upper-limit tax exemption for startups turnover is increased to Rs.100 crore up from Rs. 25 crore.

Exemptions on investments made by domestic investors on startups will only be given if it meets the below-listed criteria’s:

  • After the shares are issued, the paid-up capital complete with a share premium of the startup should not be more than Rs. 10 crore
  • The startups fair market value must be certified by a Merchant Banker
  • An investor net worth should be Rs. 2 crore
  • The average income of the investor in the last 3 financial years should be Rs. 50 Lakh or more

As of now, a startup has to simply put a request for angel tax exemption to the DIPP (Department of Industrial Policy & Promotion), with the required documents.

At present, the angel tax rate is 30.9% on the net investment which is more than fair market value of the business entity. So if a startup with a fair market value of Rs. 15 crore get an investment of Rs. 25 crore, by issuing 1 Lakh shares of Rs. 2,500 each, it will have to pay the Angel Tax amounting to a whopping Rs. 3.09 crore, on the excess Rs. 10 crore.