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Proposal to tax angel investors in Budget 2012-13: Burden to young start-ups while Angel Investors Get Tax Concessions in US and UK

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Proposal to tax angel investors in Budget 2012-13: Burden to young start-ups while Angel Investors Get Tax Concessions in US and UK

The Union Budget 2012 presented by the UPA (central) government has disappointed not just corporate India but also young start-ups. The Finance Minister proposed that the government will treat all individual investments which include genuine angel money in a company as income from other source.

 

The recent clause in India’s 2012 Budget proposes taxing Indian start-ups 30% of the amount invested by Angel investors by terming the investment as income.

 

The Memorandum of the Finance Bill 2012 states

“It is proposed to insert a new clause in section 56(2). The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income tax under the head “Income from other sources. However, this provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.”

 

It is also proposed to provide the company an opportunity to substantiate its claim regarding the fair market value. Accordingly, it is proposed that the fair market value of the shares shall be the higher of the value –

(i) as may be determined in accordance with the method as may be prescribed; or

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

 

This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.

 

Generally, angel investment or investments from individuals such as friends and families are at a very early stage of the company where VC funds usually do not come in. Only after the company sees a significant traction or the proof of concept is established, an early stage VC fund will invest in a startup. In short, the angel investment from “persons” comes in at the earliest stage. As it is well known, a startup generally does not get institutional money at a very early stage, and that gap is filled by high net worth individuals and successful entrepreneurs who provide the finances to startups as their personal investments.

 

As a standard practice, startup gets funding from an angel investor in exchange for equity. The valuation of the startup is usually based on an idea, with very little else to support it. Effectively, a new startup with an idea along with a patent, and perhaps an initial prototype may get a Rs. 10 lakh – Rs. 20 lakh funding from an angel investor for may be 10% – 20% of the company.

 

To present the concerns of the industry, Saurabh Srivastava, Chairman Emeritus, TiE Delhi-NCR, recently met with the Finance Ministry to apprise them of such concerns. According to him, the discussions were cordial and they explained the rationale of the provisions which have been proposed to curb transactions in unaccounted money. He shared with them how critical angel investments were for the country and how these measures would have an unintended but extremely adverse impact. He further discussed various options that would keep their intent intact without coming in way of angel investing. One of the suggestions that seemed to find more favour was to exempt investments under Rs. 5 crores individually and Rs. 10 crores per deal. If not be withdrawn, but they would try to do what was possible to ensure that genuine angel investments were not impacted.

 

While the present state of affairs in India is becoming startup/angel-unfriendly, the federal government in the US, including several US States, and UK are providing tax breaks to angel investors. Additionally, angel investors in Canada are pressing for a new regulation to provide tax relief similar to UK.

 

Based on a research report, as per angel investor credit programs in US, at least 21 states offer income and business tax credits to angel investors for investing in newly-formed, technology-related businesses. These investors tend to be wealthy individuals looking for opportunities to develop and establish new businesses in areas that interest them. Generally, the credits range from 15% of the investment in Colorado to 100% in Hawaii. Some criteria are used to qualify investors (for example, high networth individuals in Kansas) and targeted investment in certain sectors (for example nanotechnology in Winconsin). As a matter of fact, eleven of the 21 states enacted angel investor tax credits since 2005 (Arizona, 2005; Arkansas, 2007; Colorado, 2010; Connecticut, 2010; Kansas, 2005; Louisiana, 2005; Maryland, 2005; Minnesota, 2010; New Mexico, 2007; Rhode Island, 2006; and Wisconsin, 2005). Most of the states authorized the credits for a specified time. For example, Connecticut’s credits expire in FY 2015. Moreover, none of the states repealed the credits, but however, two states allowed them to expire, Hawaii, in 2010, and Louisiana in 2009. Furthermore, as per the provisions of the Small Business Jobs Act of 2010, it provides a 100% exemption for gains made in qualified business stock.

 

Tax breaks in UK are provided by the UK government, which has made it a priority to get funds into small fledgling businesses and it offers a 50% rebate – even if the individual making the investment isn’t paying 50% income tax. Also,, if you make a capital gain in the tax year 2012 / 13 and invest that money in a startup, then you’ll also get the 28% capital gains relief – a massive 78% relief in total. This mainly applies to investments made after April 6, 2012.

 

In Canada, the National Angel Capital Organization wants the Government of Canada and provincial governments to “adopt an Innovation and Productivity Tax Credit (IPTC) similar to the UK’s successful ten-year-old Enterprise Investment Scheme and B.C.’s Small Business Venture Capital Program.”

 

At present, most of the angel investments in India are in the technology sector and the angel investors don’t get any tax relief, while the investments are typically in the range of Rs. 30 lakhs to Rs. 3 crores.

 

It would be heartening if finance ministry makes a recommendation to Union Government to provide tax relief to angel investors instead of taxing startups on angel investments.

Send Advocate Rahul Dev an email at rahul [dot] d [at] techcorplegal [dot] com

 

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