Context:

The Union Budget 2024-2025 has proposed the abolition of the 'Angel Tax' for all classes of investors, bringing relief to start-ups. 

What is Angel tax? 

• The "angel tax" was imposed on capital raised by unlisted companies through the issuance of shares to Indian investors when the share price exceeded the company's fair market value (FMV).
  An unlisted company is one whose securities are not listed on a recognized stock exchange.
• The excess amount was considered income and taxed at a rate of 30.9%. 
• It taxed the difference between the actual capital received and the FMV of the issued shares, treating this difference as the company's taxable income.
• It was Introduced in the Finance Bill of 2012, aimed to prevent the introduction of black money into private companies through inflated valuations.
• This tax, officially governed by Section 56(2) (viib) of the Income Tax Act, 1961, was initially introduced in 2012 based on recommendations from the "White Paper on Black Money." 

Impact of Angel tax on startups 

• The imposition of the angel tax placed a significant financial burden on startups, many of which were already operating with limited budgets. 
• The requirement to pay a 30% tax on the excess investment over the fair market value (FMV) redirected vital funds intended for growth and operational expenses towards tax payments.
• This tax burden was particularly challenging for young startups in their early stages, which depend heavily on external funding to expand their operations.
• According to Private Circle Research, start-up funding in India dropped by over 62% in 2023, reaching Rs 66,908 crore from Rs 1,80,000 crore in 2022, marking the lowest level since 2018.
• One of the major issues with the angel tax was the determination of FMV. 

Impact on Angel Investors

• Angel investors, crucial for early-stage startup funding, became more cautious due to the tax implications, as their investments faced scrutiny and potential taxation.

Conclusion

• The abolition of the angel tax is a landmark decision to support startups and investors, fostering innovation and aiming to make India a global startup hub. The startup community has praised the move, calling it “long overdue.” This change resets the tax cost matrix for both domestic and foreign investors and reflects a progressive tax policy. It is expected to boost the startup ecosystem, encourage more risk capital, and foster entrepreneurial growth in India.