Inefficient taxation

Angel tax will affect the flow of FDI

Gross foreign direct investment (FDI) declined by over 16 per cent year-on-year in 2022-23. Given India’s need to increase investment, where FDI can play a crucial role, it is fair to expect the government to review policies and make necessary amendments wherever necessary to attract a higher volume of FDI. This is also crucial because of the relatively unsupportive global macroeconomic environment — growth is expected to slow along with unfavourable financial conditions. However, policy interventions seem to be moving in the other direction. The government last week notified 21 jurisdictions to be eligible for immunity from the so-called angel tax. The change has further complicated the funding environment and will inevitably affect the level of foreign investment in the start-up world.

According to Indian tax laws, an excess premium received by an unlisted company against the issue of shares, both from domestic and foreign investors, is interpreted as income from other sources and is liable to be taxed. As this newspaper reported last month, the government has sent notices to start-ups for funds raised in recent years. The provision, limited to domestic investors, was extended to foreign investors this year. Start-ups registered with the government, however, are exempt from this tax. The government has now listed foreign countries from where investors would be immune to the levy, but excluded jurisdictions such as Mauritius and Singapore. It has also been reported that subsidiaries of closely-held multinationals may be subject to the tax because the exemption has been extended only to entities such as pension funds and other board-based funds, and not corporate entities. The extension of the angel tax to foreign investors followed by an exemption list has complicated matters.
 

This tax provision was introduced in 2012 to presumably check the use of unaccounted money for subscribing to unlisted company shares. This is not to suggest that the government should not crack down on unaccounted money, but it clearly needs a better way than this. Measures like this can penalise the entire system, with implications for business activity and overall economic growth. It is always hard to determine fair valuation, which keeps changing, depending on wider market conditions. It would thus be hard for the tax department or merchant bankers to determine as to what the right valuation was at any given time. Exempting certain kinds of investors from select countries will make implementation even more difficult. For instance, it is not clear what would happen if both exempt and non-exempt entities invest in the same company at a valuation significantly higher than an estimate from a merchant banker.
 

It is worth noting here that the quality of investors also determines valuations. It is also not clear why certain kinds of investors from the UK, for example, can be exempt but not Singapore. As a report in this newspaper showed this week, foreign investment in start-ups declined 72 per cent so far this year over last year. However, according to estimates, India-focused private equity and venture capital funds were sitting on surplus funds worth $15.64 billion as of March. While an investment decision depends on a variety of macro and micro factors, the policy focus should always be on creating enabling conditions for businesses and investors. The angel tax and its extensions are unlikely to help in this context.