Angel Taxation under Income Tax is a tax imposed on capital raised by start-ups in India through the issue of shares to investors. This tax is levied under Section 56(2)(viib) of the Indian Income Tax Act, 1961. It applies to funds raised by unlisted companies that are not considered as venture capital companies (VCCs) or venture capital funds (VCFs), and where the share premium exceeds the fair market value of the shares.
Concept of Angel Taxation under IT Act 1961
The term “angel” came from the Broadway theatre, when wealthy individuals gave money to propel theatrical productions. The term “angel investor” was first used by the University of New Hampshire’s William Wetzel, founder of the Centre for Venture Research. Wetzel completed a study on how entrepreneurs gathered capital.
An angel investor (also known as a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small start-ups or entrepreneurs, typically in exchange for ownership equity in the company.
Often, angel investors are found among an entrepreneur’s family and friends. The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages.
- An angel investor is usually a high-net-worth individual who funds start-ups at the early stages, often with their own money.
- Angel investing is often the primary source of funding for many start-ups who find it more appealing than other, more predatory, forms of funding.
- The support that angel investors provide start-ups fosters innovation which translates into economic growth.
- These types of investments are risky and usually do not represent more than 10% of the angel investor’s portfolio
What is the eligibility criteria for Startup recognition?
i. The Start-up should be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership.
ii. An entity shall be considered as a start-up up to 10 years from the date of its incorporation.
iii. Turnover should be less than INR 100 Crores in any of the previous financial years.
iv. The company remains a start-up if the turnover per year does not cross the Rs 100 crore marks in any of the 10 years.
Once the company crosses the mark, it no longer remains eligible to be called a start-up. The mark of Rs 100 crore too has been improved by the Indian government in the recent past from Rs 25 crore.
v. The firm should have approval from the Department of Industrial Policy and Promotion (DIPP).
vi. The Start-up should be working towards innovation/ improvement of existing products, services and processes and should have the potential to generate employment/ create wealth.
vii. An entity formed by splitting up or reconstruction of an existing business shall not be considered a “Start-up.
BENEFITS AVAILABLE TO AN ELIGIBLE START-UP
Following benefits shall be available to an eligible start-up or its shareholders:
- Exemption from levy of angel tax under section 56(2)(viib);
- Deductions under section 80-IAC of the income tax Act;
- Liberalized regime of section 79 to carry forward and set-off the losses
- Exemption under section 54GB to the shareholder for making investment in a startup;
- Access to the dedicated cell created by the CBDT to address the problems of start-ups.
Tax Exemption under Section 80 IAC of the income Tax Act, 1961 for Start-up Post getting recognition a Start-up may apply for Tax exemption under section 80 IAC of the Income Tax Act.
Post getting clearance for Tax exemption, the Start-up can avail tax holiday for 3 consecutive financial years out of its first 10 years since incorporation.
Eligibility Criteria for applying to Income Tax exemption (80IAC):
The entity should be a recognized Start-up;
Only Private limited or a Limited Liability Partnership is eligible for Tax exemption under Section 80IAC;
The Start-up should have been incorporated after 1st April, 2016 but before April 1, 2021
Profit Exemption to eligible Start-up entities under Section 80-IAC:
Deduction at the rate of 100% of its profits and gains is allowed to an eligible start-up for 3 consecutive assessment years out of the 7 years (10 years from 01.04.2020) beginning from the year of incorporation.
As per Section 80-IAC, an entity shall be considered as an eligible start-up if it fulfils following conditions:
- It is incorporated as a company (Private Ltd. Co. or Public Ltd. Co.) or an LLP.
- It is incorporated on or after April 1, 2016 but before April 1, 2021.
- Its turnover does not exceed Rs.25 Cr (Rs.100 Cr from 01.04.2020) in the previous year relevant to assessment year for which such deduction is claimed.
- It is not formed by splitting up or reconstruction of a business already in existence.
- It holds a certificate of eligible business from the Inter-Ministerial Board of Certification.
- It is engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation
ANGEL TAX UNDER SECTION 56(2)(VIIB) OF THE INCOME TAX ACT –
Angel tax is the tax charged on the closely held company when it issues shares to a resident person at a price which is more than its fair market value.
When this provision is triggered, the aggregate consideration received from issue of shares as exceeds its fair market value is charged to tax under the head ‘Income from other sources’ under section 56(2)(viib).
Tax Exemption under Section 56 of the Income Tax Act (Angel Tax)
Post getting recognition a Start-up may apply for Angel Tax Exemption. A start-up shall be eligible for claiming exemption from levy of angel tax under section 56(2)(viib) if following conditions are satisfied:
- The entity should be a recognized Start-up;
- Aggregate amount of paid up share capital and share premium of the Start-up after the proposed issue of share, if any, does not exceed INR 25 Crore.
HOW TO GET EXEMPTION FROM ANGEL TAX
To exempt start-ups from the implications of section 56(2)(viib), the Government issued a notification dated 19.02.2019 that section 56(2)(viib) shall not apply if an approved eligible start-up company receives consideration for the issue of shares from resident investors.
However, this is subject to fulfilment of certain conditions which we will discuss in this article. It is to be noted that receiving consideration for the issue of shares from non-residents is already out of the ambit of section 56(2) (viib)