BENGALURU: The Indian start-up ecosystem, which has been reeling under a funding winter, might face a harsh and bitter winter with the imposition of angel tax on foreign investors. The amendment in the Finance Bill, 2023, means there is no exemption for overseas investors and they need to pay a tax on deals.
From now on, start-ups will find it difficult to receive funding from overseas investors and this might also drive them out of the country due to investors’ pressure, say experts. Angel tax was first introduced in 2012, mainly to curb money laundering. When start-ups receive investments from investors in India for issue of shares in excess of the fair market value (FMV) of the shares, angel tax is levied on them.
With the new amendment, if start-ups raise funding from non-resident investors, it will be considered as income and taxable.
“It looks like the government wants investors to come through only a formal AIF (Alternative Investment Fund). But there are structural challenges in having formal AIF structures at a very early stage in deep tech space where the risk is too high. But in the current situation, the early-stage ecosystem depends on angels writing smaller cheques and the same is hurt by the current move of the government,” said Suresh Narasimha, Managing Partner, CoCreate Ventures.
Foreign investors such as SoftBank, Tiger Global and Sequoia Capital, among others, have invested in many Indian start-ups. According to data sourced from Tracxn, a research platform, in 2022, start-ups raised $25.4 billion in 1,482 rounds, where foreign investors have invested in Indian start-ups in equity rounds.
There is no data on the total funding from non-resident investors alone in Indian start-ups, as multiple investors including resident investors participate in funding rounds. Investment firm Tiger Global backs many Indian unicorns including Games 24x7, Mensa Brands, Vedantu, BharatPe, PhonePe and Unacademy, among others.
The recent announcement is expected to negatively impact funding for start-ups, said Vinod Shankar, co-founder & Partner, Java Capital. “Definition of start-up, according to DPIIT (Department for Promotion of Industry and Internal Trade), is narrow and it does make it a challenge for funding series A + stages.
DPIIT provisions have a limit of Rs 25 crore for the aggregate amount of paid-up share capital and share premium for private companies to be recognised as a start-up and also several other restrictions to qualify or remain recognised as a start-up. This may lead to large tax disputes in the future,” he said.
More importantly, in the current funding environment it makes it even harder for start-ups to raise further funding from foreign investors with a sword hanging in the air in the form of Angel tax. After the scope being extended to them it is undoubtedly going to be tough for Indian start-ups to receive funding, he added.
According to PwC India’s ‘Startup Deals Tracker- CY22’, in 2022, Indian start-ups could not keep up the momentum of 2021, as there was a 33% drop in the total funds raised - $24 billion in CY2022 - compared to the previous year.The government has taken an assertive approach in directing investments, which may have become more aggressive, said Anil Jayaprakash, founder and CEO, Assertify Technologies.
“Angel tax has been expanded to include non-resident investors, which could result in increased government oversight of foreign investments. Start-ups that raise capital beyond their fair market value will be at a disadvantage, as they will have to pay extra tax on the surplus amount they received from both domestic and non-domestic investors,” he added. Some start-ups such as Zappyhire say that during the funding winter, the government should introduce right policies to make easy access to the capital other than making a bit difficult for the investors.
“At least start-ups that raise money for the first five years should be exempted as they take time to break-even and start looking for a profit,” says Puneeth Raj, co-founder and CEO, Seminarroom, an edtech start-up.Many start-up founders said that the government should reconsider the whole angel tax provision system. They say the government should be flexible in such tax regimes for those who are taking baby steps in the start-up world.
Vinod Shankar of Java Capital added that this may also incentivise start-ups to locate overseas to avoid paying the tax. India registered domestic AIF’s are exempted from this, but a significant portion of growth and late-stage capital is foreign in nature. “Reading between the lines is the government pushing for onshoring of foreign funds for India investments,” he questioned.
The Economic Survey spoke about Reverse Flipping, shifting of start-ups domicile back to India. To accelerate reverse flipping, it suggests measures such as simplification of taxation of Employee Stock Options (ESOPs) and simplifying procedures for capital flows.
It also mentioned start-ups’ funding challenges and observed that many Indian companies have been getting headquartered overseas, especially in destinations with favourable legal environments and taxation policies. But the proposed amendment in angel tax has upset many start-ups.
Though a majority of start-ups and venture firms are against this angel tax proposal, a few start-ups have also welcomed the move. According to Tejas Khoday, co-founder and CEO of FYERS, this (introducing angel tax for foreign investments in start-ups) is an excellent move as it creates a level-playing field with domestic investors.
“Preferential treatment of foreign investors gave an unfair advantage, which resulted in foreigners gaining significant ownership of Indian start-ups catering to Indian people within India. At the same time, Indian investors couldn’t benefit from wealth-creation opportunities because of the tax hurdle,” he added.
