Angel tax exemption approval process relaxed for Startups.

What is Angel Tax

Angel tax means the tax on amount of investment brought in by the investors in a startup company in pursuance of section 56(2)(viib) of the Income Tax Act, 1961.

What the industry says.

“The current regulations provide angel tax exemption only if investors are accredited investors. If investors are not accredited, then the benefit of angel tax exemption is not available to a start-up. Further, the current mechanism involves collecting detailed personal information from each investor on their financial sources for investments. Many a times, these investors are skeptical about sharing such information with start-ups. Therefore, very few start-ups come forward to make an application to the DIPP for angel tax exemption” as per the statement of Apoorv Ranjan Sharma, co-founder & president, Venture Catalysts.

Government’s move.

Earlier there was a cumbersome and time taking process for seeking Angel Tax exemption as the application has to go through inter-ministerial board, now the new applications will be directly evaluated by the Central Board of Direct Taxes (CBDT). Firms will have to submit their applications through the Department of Industrial Policy and Promotion (DIPP) website, after which it will be forwarded to the CBDT. The CBDT has also been mandated to evaluate and respond within 45 days of receiving such applications, as per the new notification. The Department of industrial policy and promotion (DIPP) has amended the earlier notification vide notification dated 16^th January, 2019.

The whole story.

The provisions of section 56(2)(viib) of the Income Tax Act, 1961 are applicable, in case where company in which public is not substantially interested, receives any consideration, from any person resident in India, for issue of shares which exceeds face value of such shares, then an amount of consideration exceeding fair value of such shares, determined under rule 11UA of the Income Tax Rules, 1962, shall be charged as income under the head other sources.

Provided that his clause shall not apply where the consideration for issue of shares is received-

(i)  by a venture capital undertaking from a venture capital company or a venture capital fund; or

 (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

In respect of clause (ii) of first proviso of section 56(2)(viib) of the Act, the central government has issued a Notification No. 45/2016, dated: June 14, 2016, whereby it has notified any person, as defined u/s 2(31) of the Act, resident in India, who make payment for shares of a startup company.

Startup Company means a company in which the public is not substantially interested and which fulfills the conditions specified in the notification of the Government of India, Ministry of Commerce and Industry. Department of Industrial Policy and Promotion, number G.S.R. 180(E), dated the 17th February, 2016 which is superseded by G.S.R. 501 (E) of Government of India dated 23rd May, 2017 which is superseded by G.S.R. 364 (E) of Government of India dated 11^thApril, 2018.

Therefore, any payment made by aforesaid person (hereinafter referred to as ‘Investor’), for subscription of shares of a startup company, which exceeds the fair value of such shares shall not be chargeable to tax u/s 56(2)(viib) of the Act.

Erstwhile Conditions.

The conditions as prescribed under the notification G.S.R. 364 (E) of Government of India dated 11^thApril, 2018 was as under:-

Meaning of Startup company.

An entity shall be considered as a Startup:-

1. Upto a period of seven years from the date of incorporation/registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India. In the case of Startups in the biotechnology sector, the period shall be upto ten years from the date of its incorporation/ registration.
2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded Rs. 25 crore

Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

Provided that an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.

Explanation-

An entity shall cease to be a Startup on completion of seven years from the date of its incorporation/ registration or if its turnover for any previous year exceeds Rupees 25 crore. In respect of Startups in the biotechnology sector, an entity shall cease to be a Startup on completion of ten years from the date of its incorporation/ registration or if its turnover for any previous year exceeds Rs. 25 crore.

Recognition.

The process of recognition of an eligible entity as startup shall be as under: —

(i) A Startup shall make an online application through mobile app or portal set up by the Department of Industrial Policy and Promotion.

(ii) The application shall be accompanied by—

(a)  a copy of Certificate of Incorporation or Registration, as the case may be, and

(b) a write-up about the nature of business highlighting how it is working towards innovation, development or  improvement of products or processes or services, or its scalability in terms of employment generation or wealth creation.

(iii) The Department of Industrial Policy and Promotion may, after calling for such documents or information and making such enquires, as it may deem fit,—

(a) recognise the eligible entity as Startup; o

(b) reject the application by providing reasons

Approval for the purposes of clause (viib) of sub-section (2) of section 56 of the Act.

(1) A Startup being a private limited company and in conformity with the definition as per definition stipulated at Para 1(a) shall be eligible to apply for approval for the purposes of clause (viib) of sub-section (2) of section 56 of the Act, if the following conditions are fulfilled: —

(i) the aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed ten crore rupees,

(ii) the investor/ proposed investor, who proposed to subscribe to the issue of shares of the startup has, —

(a) the average returned income of twenty five lakh rupees or more for the preceding three financial years; or

(b) the net worth of two crore rupees or more as on the last date of the preceding financial year, and

(iii) the startup has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.

(2) the application for approval under this para shall be made in Form-2 to the Board and shall be accompanied by the documents specified therein.

(3) The Board may, after calling for such documents or information and making such enquiries, as it may deem fit, —

(i) grant approval for the purposes of clause (viib) of sub-section (2) of section 56 of the Act, specifying the relevant details, including details of investor, amount of premium on which shares are to be issued, and the latest date by which the shares are to be issued; or

(ii) decline to grant the said approval after providing reasons.

Now, the Department of Industrial Policy and Promotion has issued notification to amend earlier notification dated 11^th April, 2018 vide Notification number GSR 34 16^th January 2019, whereby para 4 of the notification was substituted with following para:-

Amended Condition.

(1) A Startup which is recognised by DIPP under para 2(iii) (a) shall be eligible to apply for approval for the purposes of clause (viib) of sub-section (2) to section 56 of the Act for the shares already issued or proposed to be issued if the following conditions are fulfilled—

(i) aggregate amount of paid up share capital and share premium of the startup after the proposed issue of share, if any, does not exceed ten crore rupees;

(ii) The investor/ proposed investor shall have —

(a) returned income of Rs. 50 lakh or morefor the financial year preceding the year of investment/proposed investment; and

(b) net worth exceeding Rs. 2 crore or the amount of investment made/proposed to be made in the startup, whichever is higher, as on the last date of the financial year preceding the year of investment/proposed investment.

(2) (i) Application for approval under this para shall be made in Form-2 to DIPP and shall be accompanied by the documents specified therein:

Provided that in case the approval is requested for shares already issued by the Startup, no application shall be made if assessment order has been passed by assessing officer for the relevant financial year.

(ii) The application of the recognised startup shall be transmitted by DIPP to CBDT with the necessary documents.

(3) The CBDT, within a period of 45 daysfrom the date of receipt of application from DIPP may grant approval to the Startup for the purposes of clause (viib) of sub-section (2) of section 56 of the Act or decline to grant such approval.

Further, in order to maintain the secrecy of credentials of the investor the information by the investor shall be filed by the investor directly to DIPP.

Conclusion

Although the angel tax is not abolished but the process of obtaining approval for angel tax exemption u/s 56(2)(viib) has been made transparent and time bound. Further, the secrecy of information of investors has been kept in mind by letting them file their information to the ministry directly. Further, the eligibility norms for the investors has been changed, as earlier, an investor needed to have an average returned income of Rs 25 lakh or more for the preceding three financial years. As per the latest notification this is changed to minimum filed income tax returns of Rs 50 lakh for just one year.

Takeaway

Earlier a startup company as defined therein although not recognized by the board can also apply for the approval, as per the para 4 of old notification dated 11^th April, 2018, however as per the new notification, only those startups which are recognized by the DIPP will be eligible to file application for approval for exemption u/s 56(2)(viib) of the Act.

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