[Opinion] Angel Tax Abolition | Catalyzing Start-Up Growth While Navigating Tax Evasion Concerns

Vishal Gupta & Shahrukh Kamal – [2024] 166 taxmann.com 239 (Article)

The recent amendment in India’s income tax legislation, abolishing the “Angel Tax,” represents a significant policy shift and is expected to spark extensive discussion among stakeholders. To fully understand the implications of this change, it is crucial to explore the origins and objectives of the angel tax, its impact on the economy and the start-up ecosystem, and the rationale behind its recent abolition.

The angel tax was introduced in India in 2012 through Section 56(2)(viib) of the Income Tax Act to curb the circulation of unaccounted money, a longstanding issue in the Indian economy. It targeted investments by angel investors in start-ups, particularly those perceived as overvalued. When unlisted companies, especially start-ups, received equity investments exceeding the fair market value of their shares, the excess amount was taxed as income from other sources. This provision aimed to prevent money laundering and the infusion of illicit funds through inflated share valuations. Over the years, the government introduced exemptions for investments by Venture Capital Companies, Funds, and SEBI/IFSC regulated Category I and II AIFs. Additionally, start-ups registered with DPIIT were included in the exemption list, subject to certain conditions.

The introduction of the angel tax served a dual purpose. Firstly, it aimed to enhance transparency and ensure that all funds entering the start-up ecosystem were legitimate and accounted for. By subjecting these investments to tax scrutiny, the government sought to increase tax collection and reduce tax evasion, addressing the broader issue of black money that had long plagued the economy. This was seen as a necessary step to create a level playing field where all financial transactions were transparent and within the tax authorities’ purview.

On the other hand, the angel tax had several unintended consequences that significantly impacted India’s start-up ecosystem. Start-ups, inherently high-risk ventures, often require substantial capital inflows from angel investors and venture capitalists to drive growth and innovation. The imposition of the angel tax created a considerable burden on these early-stage companies, subjecting them to rigorous scrutiny and potential tax liabilities that many could ill afford. This led to a slowdown in investment, as investors became wary of the complex tax implications and entrepreneurs faced significant difficulties in raising the necessary funds to grow their businesses.

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