 "Taxing times: Income tax heat on start-ups over unexplained funds")
Several start-ups, including prominent unicorns, have received tax notices on some supposedly unexplained investments in them between FY19 and FY21.
The notices, under Section 68 of the Income-Tax Act, were served across the start-up spectrum — fintech, aggregators, and edtech. They sought an explanation on the nature and source of the investment, people familiar with the matter told Business Standard.
The minimum investment in question is Rs 100 crore. However, the total could not be ascertained.
Section 68 of the Act deals with unexplained funds credited to the books of taxpayers and for those the source is not given. The Section is invoked mainly to know the identity, creditworthiness, and genuineness of the share issuance.
Some of these notices questioned the foreign investors’ regional holding, the valuation prescribed, and the purpose of the loan taken by the investors. Subsidiaries of some multinationals too were queried about the funds they received from their parent firm.
“An explanation is being sought, considering the growing menace of round-tripping of funds -- the reason for which the angel tax provision has been extended to non-resident investors,” an official in the know said.
Round tripping refers to money that leaves the country through various channels and comes back in the shape of foreign investment. The official said the negative list of the angel tax had been proposed keeping the regulatory framework in mind.
Sovereign wealth funds, pension funds, and portfolio investors belonging to 21 jurisdictions and registered with the Securities and Exchange Board of India will be exempt from the provisions of the angel tax because they are highly regulated entities.
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Easing rules for angels?
Taxing times
- Notices served under Section 68 of the I-T Act
- Section deals with 'unexplained' funds credited in the books of taxpayers
- Some prominent unicorns, MNC subsidiaries among those sent notices under tax net
- FY19-FY21 period under review; move to check possible round-tripping
- New Angel tax norms brought several global firms' investments under tax net
Sources said the government had received suggestions from certain private equity and venture capital funds to ease some conditions for angels. For instance, the relaxation provided under draft rules for price matching and 10 per cent safe harbour is restricted to equity shares and should be extended to convertible securities.
“This proposal, although it primarily relates to tax, could have a bearing on foreign investment deals under forex rules. Inbound private equity transactions generally use convertible securities such as compulsorily convertible preference shares with a conversion ratio. If these securities are issued at a price higher than their valuation price, the difference in the two will be subject to angel tax,” said Lalit Kumar, partner, J Sagar Associates.
Experts pointed out not including Singapore, Mauritius and the UAE in the list of 21 jurisdictions kept almost all significant private equity/venture capital funds and start-ups in which they invested on their toes.
“The angel tax rules will have a far-reaching effect and apply to any foreign investment even from the list of the 21 countries,” said Rajesh Gandhi, partner, Deloitte India.
Even a parent in the US or Europe investing in its subsidiary or joint venture in India will have to comply with these norms.
A significant amount of investment in Indian start-ups is foreign capital (from vehicles based in Singapore and Mauritius) and responsible for overall industry growth and even making them unicorns.
Industry stakeholders say the new angel tax provision will aggravate the problems of start-ups. Some start-ups received notices in the previous fiscal year under both Section 68 and Section 56.
Section 56 (2) (viib), also known as angel tax, says any difference between the fair market value and the face value of shares issued by a company is taxable. From April 1, the angel tax has been extended to investment by foreign investors. Earlier it was only for resident ones.