With no angel tax, startups and investors hope for better funding scenario

While the abolition of the angel tax is a big win for startups and their investors, the ecosystem is not out of the woods yet

The recent Budget announcement to abolish angel tax, which affected the Indian startup ecosystem, is being seen as a sentiment booster for investors, promising to incentivise high net-worth individuals, family offices, and foreign venture capitalists to loosen their purse strings. 

Still, investors are cautious about the decision's immediate impact on funding volumes, anticipating any increase in funding will likely be gradual.

“No foreign investor wants to invest in a country with a risk that his/her investment can be arbitrarily treated as taxable income (of startups). This move (the abolishing of angel tax) will streamline the investment process and reduce the ambiguity surrounding tax treatments, thereby encouraging more foreign investment into Indian startups,” said Anirudh A Damani, managing partner at Artha Venture Fund, a micro-VC fund.

Finance Minister Nirmala Sitharaman announced the repeal of the angel tax during her 2024-25 Union Budget presentation last week, noting that it would no longer apply to companies raising capital from April 1, 2024, onwards. The angel tax was introduced in 2012 to prevent cases of tax avoidance and misuse of funds.

After Sitharaman’s announcement, Rajesh Kumar Singh, Secretary, Department for Promotion of Industry and Internal Trade (DPIIT), said the decision could help bring an end to the funding winter that has gripped the Indian startup scene. “Venture capitalists, high net-worth individuals (HNIs), and foreign investors — all those who were hesitant about investing in startups due to the compliance burden of having to pay the tax -- will be a little more forthcoming,” Singh told Business Standard last week.

Funding for Indian startups plunged by 72 per cent year-on-year in 2023, hitting a seven-year low of $7 billion, compared to $25 billion the previous year, according to data from market intelligence platform Tracxn.

“Previously, venture capitalists, HNIs, and foreign investors were bogged down by compliance nightmares. The move has removed this burden, and we are likely to witness a more inviting funding landscape,” said Ankit Kedia, founder and lead Investor at early-stage investment firm Capital A.

Moreover, the angel tax abolition is expected to accelerate investment processes by reducing the need for extensive documentation and valuation reports. “By reducing the time lag between an investor’s decision to invest and the completion of the investment, it ensures that funds reach deserving startups quicker… This accelerated flow of investments will undoubtedly contribute to alleviating the funding winter,” said Damani.

However, investors caution that the removal of the angel tax might not drastically alter overall deal volumes immediately. “I don’t think this will have an immediate drastic impact on fund flows, but it’s definitely going to have some improvement in terms of reducing friction,” said Vinod Murali, co-founder and managing partner of Alteria Capital, a venture debt fund. “This is more comparable to removing a roadblock. Ultimately investors have to be willing to write a cheque for a deserving startup; this step reduces friction… In an environment where funding has not been very easy, it is always better if the roadblocks are fewer.”

While the scrapping of angel tax is a significant win for startups and investors, it doesn’t mean the ecosystem is free of challenges. “There are other challenges like complex regulatory requirements, constantly changing tax policies, and the requirement of multiple licences and permits — all of which can be both time-consuming and costly,” said Kedia.

Investors continue to highlight the absence of a “clear and consistent” framework for foreign investments and the stringent reporting standards that come with it. The need to file multiple tax returns, maintain extensive documentation, and navigate complex tax laws often delays operations and increases costs. “Starting, operating, and shutting a business in India is still quite laborious. While there has been some improvement in this context, we still have a long way to go in terms of making life easier for founders,” Murali pointed out.

Industry stakeholders, thus, are urging the government to streamline regulatory processes, offer clearer guidelines on tax and investment policies, and establish a more predictable legal framework.


Likely Impact

Eased compliance burden 

More foreign investment into Indian startups

Will contribute to alleviating funding winter

Not likely to have a profound impact on overall deal volumes

Challenges remain: Complex regulatory requirements, constantly changing tax policies, and requirement of multiple licences and permits