Angel tax is a term used to refer to the income tax payable on capital raised by unlisted companies via issue of shares where the share price is seen in excess of the fair market value of the shares sold. The excess realisation is treated as income and taxed accordingly. The tax was introduced in the 2012 Union Budget by then finance minister Pranab Mukherjee to arrest laundering of funds. It has come to be called angel tax since it largely impacts angel investments in startups. Current rate is 30% as the investment received is deemed to be taxable under income tax.
The government issued a notification in April this year to give exemption to startups under Section 56 of the Income Tax Act in cases where the total investment including funding from angel investors did not exceed Rs 10 crore. For the exemption, startups were also required to get approval from an inter-ministerial board and a certificate of valuation by a merchant banker. According to the notification, the exemption would apply only when the angel investor had a minimum net worth of Rs 2 crore. There is no definitive or objective way to measure the ‘fair market value’ of a startup. Investors pay a premium for the idea and the business potential at the angel funding stage. However, tax officials seem to be assessing the value of the startups based on their net asset value at one point. Several startups say that they find it difficult to justify the higher valuation to tax officials.