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India redefines “startups” to provide young companies relief from angel tax

Quartz logo Quartz 2/20/2019 Ananya Bhattacharya
Youth in lit angel costumes ski down a slope in the town of Zheleznogorsk© Provided by Atlantic Media, Inc. Youth in lit angel costumes ski down a slope in the town of Zheleznogorsk

The Narendra Modi government has finally delivered on its promise to Indian startups.

The commerce ministry yesterday (Feb. 19) notified several measures to simplify the process of exempting startups from angel tax, levied when a privately-held company raises funds at a rate higher than its “fair valuation.” Currently, it is applied at over 30% in India.

Among other things, the government shall now consider an entity as a startup for up to 10 years after its incorporation as compared to seven years earlier, provided its turnover for any one financial year has not exceeded Rs100 crore. A startup must also be “working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation,” the government said in a notice.

In addition, now startups can apply for an exemption from angel tax if their paid-up share capital is up to Rs25 crore, compared to Rs10 crore earlier.

Angel tax was introduced in 2012 with a motive to curb money laundering via small companies. And while the government eased some norms on Feb. 19, it has still ensured that the money raised by a startup is put to the right use. For instance, to be eligible for tax exemptions, a startup should not invest its funding into an immovable property, transport vehicles above Rs10 Lakh, loans and advances, and capital contribution to other entities, among other things.

The riders aside, Indian startup community is celebrating.

“This clarification would help avoid potentially significant tax challenges faced by startups and allow them to focus on their core activities,” said Bhavin Shah, financial services tax leader at consultancy PwC India.

Good times are here

In some cases, penalties on late payments of the angel tax have been higher than even the funding round being taxed. Over seven in 10 startups that raised angel capital received one or more tax notices with 28% receiving three or more, according to a survey by online community platform LocalCircles and the Indian Venture Capital Association (IVCA).

The issue peaked in the last couple of weeks when tax authorities withdrew funds without any notice from the bank accounts of at least two startups. On Feb. 09 and Feb.10, entrepreneurs and investors in the country trended #ShutdownIndia on Twitter to show how far removed reality is from prime minister Modi’s highly publicised Startup India initiative, aimed at supporting entrepreneurship.

“Angel tax had begun to dampen the enthusiasm of angel investors and startups who had begun migrating abroad,” Saurabh Srivastava, chairman of IAN, told Quartz in a statement. “This (the measures announced yesterday) will transform India’s economy, generate millions of jobs, and solve India’s pressing challenges in healthcare, education, agricultural productivity, clean energy, and much more.”

But…

However, Indian startups still won’t have it as easy as their peers in Silicon Valley or Singapore.

For one, there is no end to red tape. Only the startups registered with the government’s department for promotion of industry and internal trade (DPIIT) will be eligible for exemptions, according to the Feb. 19 notification. For this, startups will still need to submit an online application, complete with a copy of the certificate of incorporation or registration as well as a write-up about the business.

Besides, the government has not provided any escape for the hundreds of firms already slapped with tax notices.

According to Rehan Yar Khan, managing partner at investment firm Orios Venture Partners:

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