Tax On Angel Investment: What Industry Watchers Say

19 Mar, 2012

The clause in the Union Budget 2012, which proposes to tax angel investments, has been termed by more than a dozen industry watchers as "a death blow" which has the "potential to kill entrepreneurial-startup ecosystem" in India. The decision has already created trepidation among entrepreneurs and might lead to depressing valuations for these companies.

Under this proposal, the government will treat all individual investments (which will also include genuine angel money) in a company as "income from other sources" and they will be subject to a tax of 30 per cent at the hands of the companies (including all genuine startups).

The measure, which has been intended to weed out black money and corruption, is expected to have deep impact on the still nascent but growing ecosystem (see table), if implemented.

"It is true that there are reports of misuse of pricing by some vested interests, to evade taxes. The solution to counter this is not to amend the law, giving the income tax officers the right to decide about valuation, but to seek the source of investment from the investors," says TV Mohandas Pai, former Infosys director and the current chairman of Manipal Universal Learning.

"This provision will inhibit the free operation of the market for angel capital, hurt startups and generally become one more way of inhibiting growth, and funnily enough, will make the Income Tax Department the sole arbiter of valuation for angel financing," he adds.

Agrees Praveen Chakravarty, CEO of Investment Banking & Institutional Equities at Anand Rathi, adding that this places unnecessary and arbitrary power in the hands of assessing officer, which may lead to exploitation of these businesses. "For a small business, 30 per cent less money has a huge impact and it could mean cashflow for 6-12 months," says Chakravarty, who is also a co-founder of Mumbai Angels.

The move can also impact the value of investments as startups move to venture capital and private equity funds after raising angel funding. "I call angel funding India's community capital and it's very critical. What is really worrying is that angel-funded companies are a large feeder for venture capital and PE industry, sort of a nursery," notes Gopal Srinivasan, chairman & CEO of TVS Capital.

Industry watchers feel that the move has come as the government does not understand the startup value chain while it comprehends the importance of financing micro, small and medium enterprises (MSME). In the same budget, it has announced a Rs 5,000 crore India Opportunities Venture Fund with SIDBI, for equity in MSMEs. It has also allowed pass-through taxation benefits for domestic venture capital funds.

For entrepreneurs like Rohan Dighe, founder of Social Deal Factory, the news has come as a surprise as he is in talks for a round of angel funding. This would mean pushing the investors to get the deal done quickly in order to avoid these tax implications, which will be applicable from April, if the budget is passed in its current form.

Various angel groups across the country have already started the process of reaching out to the government. And many feel that the government needs to be made aware of the asset class.

"In other countries, governments are encouraging and incentivising angel investing. In India, various business bodies like CII, FICCI and Assocham need to educate the Finance Ministry and the Bureaucracy on the beneficial impact of angel investing on the economy and job creation," says Rajesh Sawhney, founder of Superangels of India Network and the president of Reliance Entertainment.

The move, if implemented, may lead to structure overhauls where startups start registering overseas or angels look at registering with the SEBI as VCFs. Both moves will have their own complications. It has also been recommended that the tax rule should be implemented after a certain limit (i.e., Rs 10 crore), which would be beyond the range for a typical angel round.

Many startups have also been increasingly approaching non-resident Indians over the past few days as they are likely to escape this tax net.

For more reactions, click here.