The tax assessment notices issued by the Income-Tax [IT] department to thousands of start-ups [acronym for companies which turn ‘innovative idea’ in to attractive business venture] and tax demands raised on hundreds of them has led to widespread consternation.
The iSPIRT, a think-tank for the Indian software products industry, estimates that over 38% of the start-ups in the country — 39,000 at last count — have received one or more ‘angel tax’ notices during 2018 leading to a drop of 21% year-on-year in critical capital infusion in these entities at the seed stage. It has sought immediate intervention by Prime Minister, Modi to halt these tax notices.
The government has responded by quashing all tax assessment notices. As regards, cases where tax demands were raised, those will be disposed of after appeal; meanwhile, the field formations have been directed not to take recourse to any coercive action.
It has also substantially liberalized norms for both the investors as well as the start-up entities to ensure that most of them don’t receive any tax assessment notice or demand in the future.
The measures announced by the department for promotion of industry and internal trade [DPIIT] – the policy making body in the ministry of commerce – include (i) increase in the funding limit by unlisted firms and individuals in a start-up that would be exempted from the angel tax from the current Rs 10 crore to Rs 25 crore; (ii) no such limit for investments by listed firms with net-worth above Rs 100 crore or turnover of Rs 250 crore; (iii) firms to be called start-ups up to 10 years, instead of current 7 years and increase in their turnover limit from existing Rs 25 crore to Rs 100 crore.
Henceforth, a start-up fulfilling the above criteria [albeit relaxed] needs to submit ‘memorandum of information’ to DPIIT who after satisfying itself about eligibility and compliance with the norms, will communicate to Central Board of Direct Taxes [CBDT]. The CBDT in turn, will ensure exemption of the concerned entity from the tax.
The demand for tax is raised after the IT officer has conducted thorough investigation and scrutinized relevant facts/records in the light of the extant law and rules establishing a prima facie case that the entity is liable to pay tax. Furthermore, the fact that demand notices have been served on over 100 companies shows that lot of research and analysis had gone in to the exercise.
If, now the government not only withdraws all the notices but also, exonerates firms from tax in the future, this either tantamount to abject surrender to the pressure mounted by the start-ups lobby or an admission that actions of the department were flawed. So, what are the facts of the case? What prompted the drastic move?
The ‘angel tax’ is an impost on the extra capital raised by an unlisted firm through the issue of shares over and above their fair market value. According to Section 56 of the I-T Act [1961], the excess capital so raised [difference between the purchase price and fair market value] is treated as ‘income from other sources’ and hence taxable.
Under a special dispensation carved out for the start-ups, in April 2018, the government had said if “the aggregate amount of paid-up share capital and share premium of the start-up after the proposed issue of shares does not exceed Rs 10 crore”, the firm could apply to an eight-member inter-ministerial board for the tax relief.
Yet, the tax authorities issued notices majority of these being on start-ups whose share capital and premium amount was less than Rs 10 crore. This was based on an assessment that the money invested in such entities was essentially unaccounted cash or black money [as it is known in common parlance]. This unaccounted cash is camouflaged in the exceptionally high premium.
With these underlying facts, unambiguously the premium amount on the share is income in the hands of the start-up and the IT has strong justification to tax it. This is taxable irrespective of the quantum of investment – less or more than Rs 10 crore.
This fundamental point can’t be brushed aside simply because the recipient of the laundered money happens to be a start-up – firms which offer huge potential and are crucial to a rising India. The government should take a re-look at the package offered by DPIIT. It must refrain from giving the start-ups blanket exemption from levy of angel tax. Instead, it should carefully articulate its stance that ‘the intent is only to sternly deal with the evil of black money’.
While, there is always scope for refining the methodology for arriving at the fair market value [for instance, the tax man may take a re-look at the traditional methods like discounted cash flows in the context of new areas operating in the technology space] for the purpose of arriving at the taxable income, to do away with the levy of angel tax altogether is totally untenable.
Yet, if the government decides to go ahead with the implementation of the DPIIT package – purportedly under fear that this will affect flow of funds – this will send a wrong signal. It means that our policy makers are not serious about blocking the most commonly use route for laundering black money.
While, there can be no two opinions on the overarching need to ensure increase in funding for start-up, the government must not do anything which compromises on its fight against black money. This will also be in sync with Modi’s philosophy of ‘zero tolerance’ for corruption and black money.