“The abolition of the angel tax in the 2024 Budget is a landmark decision that is expected to have a profound impact on India’s startup landscape. It addresses long-standing concerns of startups and investors, paving the way for a more vibrant and dynamic entrepreneurial ecosystem.” – Finance Minister Nirmala Sitharaman
Introduction
India’s enormous commercial potential for startups has earned it the title of “the poster child of emerging markets.” With a population of around 1.3 billion, even niche products might have a sizable market in this nation. India’s economic system shifted toward being more market-based in the 1990s due to economic reforms. India’s GDP grew by 7.0 percent in 2018, making it one of the world’s largest economies rising at the fastest rate. As a result, it is thought that the Indian market can present a wealth of chances for new businesses. [i]
India is home to the world’s 3rd largest startup ecosystem (NASSCOM Start-up Report, 2019), and it has produced numerous successful startups in the past two decades, including Boat, Paytm, and Ola. [ii]Over the past ten years, India has seen a steady increase in the number of startups; currently, roughly 9000 technology-based start-ups are operating there, with annual growth rates ranging from 12 to 15%. In just the first nine months of 2019, the Indian startup ecosystem drew in over 390 active institutional investors who backed deals totaling over $4.4 billion. [iii]
Regulatory Challenges and Reforms in India’s Startup Ecosystem
The Indian government has implemented rules designed to improve the business environment for fresh businesses. On the other hand, most people believe that the current regulatory environment in which startups operate is challenging, ineffective, and unpredictable. Startups have been reported to find the tax policy and its implementation unfriendly. This relates to the July 2017 introduction of the Goods and Services Tax (GST). The details of how it operates and which products qualify as tax bases remain obscure. Even if they are not yet profitable, startups must file their taxes regularly. Moreover, companies face the risk of a liquidity constraint if consumer payments are delayed, which happens frequently. They run the risk of paying hefty penalties if they don’t file the tax on time. On the other hand, the so-called “Angel Tax,” was implemented in 2012 to reduce money laundering. [iv]
A startup company might receive funding from angel investors in return for loans or equity in the company. An angel investor group may be established as an alternative, and members would combine their funds to invest in a portfolio of businesses. They are frequently seasoned business owners aware of the complexities and dangers associated with the industry.
The Indian startup ecosystem, has a dominant position and is causing a fundamental shift in angel financing. Angel investors have a network that can assist entrepreneurs with ideas that have the potential to be profitable. In the Indian market, there are two different kinds of angel investors. Super angels and pure angels are the two categories. Super angels are entrepreneurs who have turned into investors; those who do this full-time are known as pure angels. One of the most well-known angel networks in the world today is the Indian Angel Network, which has more than 400 members from various industries. Its members are dedicated to identifying companies at an early stage, closely monitoring them, and providing them with business connections and quality time.
The idea of an angel tax is covered in Section 56(2) (viib) of the Income Tax Act of 1961. Every startup (i.e., unlisted businesses whose shares are not available for purchase on the stock market) that gets investment from an angel investor is required under the Finance Act, 2012, in the IT Act to provide a specific amount of contributions to the government.[v] If the entire investment is above the company’s Fair Market worth (FMV), then this tax becomes applicable. An investment that exceeds fair market value (FMV) is classified as “income from other sources” and is subject to an angel tax. To support the expansion of India’s start-up ecosystem, the Angel tax has been abolished effective in the fiscal year 2025–2026, as stated in the Union Budget 2024. Startups sponsored by Indian residents are the key subjects of angel tax. Angel tax forces startups to share a large portion of the investment, these startups typically lose a lot of money in taxes.
Angel tax abolition was requested by venture capitalists and industry professionals to further support creating a more favorable environment for startups in India. With the removal of angel tax, startups may find it easier to secure funding from angel investors, leading to a more vibrant and dynamic startup ecosystem. Eliminating the tax lessens the financial strain on startups, enabling them to better direct resources toward expansion and improvement. The government wants to encourage innovation and entrepreneurship by drawing in more investors to the startup scene by getting rid of the tax. Startups’ financial and legal procedures will be made simpler by reducing regulatory obstacles associated with funding. With tax-related concerns taken care of, startups may now concentrate more on their core operations and innovation. Startups and investors greatly benefit from India’s removal of the angel tax.
Conclusion
Reducing tax-related risks increases investor confidence and facilitates domestic and foreign investment attraction. Taxes on valuations are no longer a financial barrier for startups, allowing them to keep more money for expansion. It frees up time for entrepreneurs to concentrate on innovation and growth by streamlining compliance and lowering the need for valuation disputes. The action strengthens India’s startup ecosystem by promoting a more welcoming investment climate, promoting entrepreneurship, job creation, and alignment with the government’s “Startup India” aim. Therefore, the removal of the tax is a boon to the Indian Market and thus would inspire more people to invest in Indian companies and restore investor trust, which could result in additional funding and industry expansion.
References:
[i] Korreck, Sabrina. “The Indian startup ecosystem: Drivers, challenges and pillars of support.” ORF Occasional Paper 210 (2019): 193-211
[ii] Manek, Aarav. “The Effects of the Angel Tax on the Indian Start-Up Ecosystem.” Journal of Student Research 12.4 (2023)
[iii] Satyanarayana, Krishna, Deepak Chandrashekar, and Bala Subrahmanya Mungila Hillemane. “An assessment of competitiveness of technology-based startups in India.” International Journal of Global Business and Competitiveness 16.1 (2021): 28-38
[iv] ibid
[v] Rao, SV Ramana, and Lohith Kumar. “Role of angel investor in Indian startup ecosystem.” FIIB Business Review 5.1 (2016): 3-14
~ Sanjay Sethiya is the Managing Partner at Law Square, Advocates & Solicitors.
~ Sumedha Srinath is an Associate at Law Square, Advocates & Solicitors.