The taxation of start-ups, right from the seed funding to angel and series funding, has been anything but predictable. Among the other issues, the provision for taxing angel investments (angel tax) has definitely caught media's attention. Introduced in 2012, Angel Tax is an income tax on super normal premium garnered by start-ups on issuance of equity (vis-a-vis fair market value of shares), from resident investors.

To begin with, there was no cap/qualification on levy of such tax when introduced in the statute, which means any resident seed/angel investment into start-ups, regardless of its origin or size, came with an extra tax cost, at the investment stage itself. A fundamental question raised for wider policy debate is, whether the levy of such a tax is in consonance with the income tax law, which seeks to tax 'income' and not 'capital' as the basic tenet of taxation. This question is yet to find a logical conclusion, especially given that a few more similarly looking provisions have since been enacted, thus blurring the line. In the context of start-ups, a relevant bargain is that the qualifying start-ups are eligible to income-linked tax holiday, which is rather an aberration now, given the tax policy drive to phase out nearly all such tax exemptions; albeit this should not justify the very basis of angel tax, which is a tax on capital itself and not on the income.

Now, moving to the legal debate on whether to be or not to be, there have been widespread discussions on what should be an appropriate framework and if angel tax should stay.

Representations before the Department for Promotion of Industry and Internal Trade (DPIIT) have been abound in the last couple of years. The discussions have ricocheted from questioning the legality of the levy per se, to limiting the impact on cases where the source of investments could not be established beyond doubt, to finally land on the principle that taxability of super normal premium ought to be taxed beyond an investment threshold, consistent with start-up qualification criteria under prevailing regulations. 

Most recently, having received representations from angel investor forums and tax professionals, the government has rolled out a set of rationalisation measures, notably to provide broad-based exemption from applicability of angel tax rule to all start-ups with paid up capital less than Rs 250 million. The notification giving effect to the policy move also enhances the turnover threshold materially (to Rs 1 billion) for a new set up to qualify as eligible start-up. The additional requirement of inter-ministerial board/CBDT approval for angel tax exemption has been done away with and that is, to my mind, the most significant, procedural bonanza for the industry, which has been marred by multiple approval requirements before business, could take off the ground. The credit needs to be given to policy think-tank, i.e. DPITT for having automated the start-up recognition process in last few months. Having said, there are still a few nuances which require attention. Here is a quick summary:

• While the IMB certification is no longer required for recognition of start-ups, the tax holiday provisions under Income-tax Act continues to require such certifications for eligible start-ups. It's rather credible to say this procedural alignment ought to be in offing, more suitably through a legislative amendment as the re-elected government would present the full budget for the financial year 2020.
• Under the February notification, exemption from angel tax levy is linked to fulfilment of a set of end-use conditions vis-a-vis investment proceeds, for 7 years. Whilst the underlying intent would be to ensure investments are not diverted to personal luxuries/sin goods, which also emerged in roundtable discussion hosted by the DPIIT with stakeholders, the embargo on downstream investments as well as on loans and advances are far too constraining. It is imperative to revisit these end-use tests to limit investments into sin-use goods.
• Besides, the restriction should be limited to investments drawn down from angel category of investors, as there would be no logic of fettering artificial end-use conditions onto otherwise freely permissible FDI equity instruments/internal accruals.
• To provide for a better playing field, levy of Minimum Alternate Tax should be revisited for eligible start-ups.
• Exemption from angel tax law should be extended to AIF Category II investors, thus bringing parity with AIF Cat I investors; there is very little or no technical argument against this idea and ought not to be a hard policy decision to implement.

Barring the above rationalisation and procedural alignment, the angel tax debate ought to be left alone, lest it deteriorates into something less meaningful. That said, another important policy breakthrough that the start-up ecosystem would anticipate is, a categorisation of a new investor class with established wealth and earning track record, or accredited investors to encourage and incentivise large-ticket investments into eligible start-ups. Preliminary discourse and outcome from stakeholders' consultation held by DPIIT suggests this could well be a credible policy idea, which has the potential to unleash a wave of investments from accredited investors, looking to make sizeable equity contributions provided impunity from angel-like tax is granted.

(Sumit Singhania is Partner, Deloitte India)