After start-ups, now investors start receiving 'angel tax' notices

Angel investors are being asked to submit recent statements of bank accounts, income tax return and, in some case, the source of their capital, within a stipulated timeframe

After start-ups, the contentious ‘angel tax’ issue has also started haunting angel investors. Multiple investors and start-ups that Business Standard spoke to confirmed that they have been served notices, asking them to explain the valuation of the company they have invested in. 

Angel investors, whose early bets are typically on the ‘idea’ and the founding team of a start-up, are being asked to submit recent statements of bank accounts, income-tax (I-T) returns and, in some cases, the source of their capital, within a stipulated time frame.

“Earlier the notices were coming to only the companies, seeking clarification on market valuation, share premium, and permanent account numbers of directors. Now the tax department has started sending notices to every angel investor,” said Sunil Goyal, managing director at venture capital (VC) fund, YourNest.

The point of contention is a 2012 law, infamously termed ‘angel tax’. For start-ups raising capital at a valuation higher than their fair market valuation, as determined by the tax department, the difference in value is deemed as earning and is thus, taxed at 30 per cent. Investments from the Securities and Exchange Board of India-registered VCs and alternate investment funds are exempted from the rule.

Though it was put in place to prevent people from laundering money into shell firms to evade tax, the authorities are allegedly using it callously against every small private company. For genuine start-ups raising money from high net-worth angel investors, it has become a pain to follow up on the paperwork with the I-T department. 

Start-ups complain they run into a wall when their valuation, often determined by a recognised investment manager or a chartered accountant (CA), is rejected by the I-T officers. The assessing officer only looks at the book value — calculated on assets, liabilities, and revenue — and cannot be compared with how tech companies and start-ups are valued, said Siddarth Pai, a founding partner at VC firm, 3one4 Capital. 

“You show the I-T wing the valuation report given by the merchant banker. The assessing officer looks at it and asks for your financial performance over the last three years. He compares the two, and says ‘you projected your income as so much but it didn’t reach there, and your expenses are higher’. He disregards your valuation report and says on that the basis and the actual performance, your valuation is so much,” said Pai, adding, “That’s ridiculous. Valuations are not on the book value.”

According to start-ups and angel investors, they are seeing a surge in the number of notices since August this year, for transactions carried out in 2015-16. The start-ups that raised this fund have since used up that money, raised follow-on rounds, or even have been acquired. The retrospective nature of the tax demand is dampening investor sentiments as they, and start-up founders, don’t want to end up in the tax avoidance list. 

“There is a notion in the market that if you do a start-up, don’t have your holding company in India. Such notices will only make that notion true. If I set up in Singapore, the Netherlands or Mauritius, even I will be taxed on my income in India, the Reserve Bank of India will not be able to quiz me on the valuation part,” said Dhruv Verma, the chief executive at GolfLan, a start-up. Verma’s firm received a tax notice early this year.

The influx of tax notices is seen even as the government in February this year clarified that “no coercive measure to recover the outstanding demand would be taken”. 

A Wednesday circular by the Department of Industrial Policy and Promotion, the government body that looks after start-ups, said the ministry is in consultation with the Department of Revenue to come up with remedies.

ANGELS IN DISTRESS

• Angel investors are being asked to submit recent statements of bank accounts, I-T returns and, in some cases, the source of their capital
• For start-ups raising capital at a valuation higher than their fair market valuation, the difference in value is deemed as earning and is taxed at 30%
• Start-ups complain they run into a wall when their valuation is rejected by the I-T officers