Finance Bill 2023: Angel tax another hiccup for start-ups amid funding woes

At a time when the technology sector is witnessing a funding winter, investment firms and start-ups haven’t received any significant relief from the proposed change in the angel tax regime. Experts say that this might create a hindrance to the flow of foreign funding for Indian start-ups.

Various stakeholders have been suggesting excluding investments from foreign companies in start-ups from the angel tax regime. However, as per the list of amendments to the Finance Bill, passed in the Lok Sabha on March 24, there is no change in the original proposal to angel tax.  The proposed changes will come into effect for the assessment year 2024-25 or the financial year 2023-2024.

“With the passing of the Finance Bill, 2023 – the applicability of angel tax on foreign investors has been cemented. The only two classes of investors whose investments are exempt from angel tax are SEBI-registered CAT I and II AIFs as well as IFSCA-registered CAT I and II AIFs (under the IFSCA FME Regulations, 2022),” said Siddarth Pai, Founding Partner 3one4 Capital and Co-Chair, Regulations Affairs Committee, Indian Venture and Alternate Capital Association (IVCA).

“There was confusion about whether this goes live from April 1, 2024 or April 1, 2023. But the memorandum to the Finance Bill 2023 clearly states that it applies from Assessment Year 2024-25, which is Financial Year 2023-24. April 1, 2024 in the Finance Act refers to the Assessment year, not financial year,” Pai explained.

However, the Finance Ministry said that all concerns raised by stakeholders in implementing this proposal would be addressed.

Anirudh A Damani, Managing Partner, Artha Venture Fund, an early-stage micro-VC fund, said that the move is meant to check money laundering.

But, Gaurav VK Singhvi, co-founder of We Founder Circle (WFC), an investment platform for early-stage start-ups, said, “Now is not the right time to remove the exemption for foreign funds and non-resident investors.”

The new tax provision, experts say, could negatively impact the investments by foreign investors, including SoftBank, Sequoia and Tiger Global.

Top venture capital firms such as Tiger Global, Accel, Softbank and Sequoia Capital India have moved to small ticket sizes as the funding winter persists. Investments by these large players have come down drastically in 2022 and experts warn that the trend is expected to continue.

“Maybe the government believes that foreign funds may be able to set up AIFs in Gift City under SEBI. That said, there is always a possibility that global investors might pressure start-ups to move overseas and invest in these funds, which means that start-ups may domicile overseas – unless we have exemptions under the proposed Angel Tax,” Singhvi said.

However, companies following prudent practices are expected to emerge unscathed. This, coupled with a faraway deadline of the next financial year, should allow foreign investors ample time to adjust their structures, preventing any knee-jerk reactions. However, concerns remain.

Regardless of the impact, the amendment suggests that the government is indeed inclined to favour domestic investors, particularly SEBI and IFSCA-registered Category I and II funds, which are exempt from the angel tax.

“Rather than resisting these changes on the grounds of tax avoidance, it would be more beneficial for long-term investors to align with the government’s vision,” Damani added.

Industry watchers claim that the start-up ecosystem still holds out hope for exemptions to international institutional investors. 

“The Central Government is empowered to (provide exemptions) via notification,” Pai says, adding that, “The hope is that the notification comes before April 1, 2023 so that ongoing funding rounds aren’t dislocated.”