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Despite the government’s decision to exempt startups from the ‘angel tax’ on investors, many companies may not benefit from this because of a caveat: Only firms certified as startups under new government norms will be exempt from ‘Angel tax’ and are eligible for other tax-related benefits, according to The Economic Times.

In February, the government said that  startups will have to be certified by an inter-ministerial panel, and they will have to fulfill the following criteria:

– Firm should be not be more than a five years old.
– Should have an annual turnover of less than Rs 25 crore.
–  Must work towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

The report pointed out that there are not many startups which have been certified. A VCCircle report says that only 70-80 startups have applied for certification and that only 1-2% of them will get the certification as it is difficult for companies to demonstrate innovation in their product or services. It also added that the decision would not apply to retrospective investments.

The tax

The tax was introduced in the Finance Bill of 2012 by then finance minister Pranab Mukherjee. Funds which were raised by an unlisted company through issuing shares were covered under this tax to the extent the amount is in excess of the fair market value. The companies would attract a corporate tax of 30% as the additional funds were reported as other income. Many startup valuations are far in excess of market valuations as they are based on the promise of the idea and not its immediate worth. In such a case, they would end up losing a chunk of inflow to the tax.

Last week, the government announced that resident angel investors, domestic family offices or domestic funds which were not registered as venture capital funds will not attract the ‘Angel tax’.

MediaNama’s take

From what we can make out, the exemption would not really provide any relief for startups. Anupam Mittal, CEO of Shaadi.com, told the Economic Times that only the government-approved startups will be exempted. This begs the question: How does the government decide if a startup is ‘innovative’ or not? Some startups may not have an original idea, but can execute it well. The 30% tax on funds which would be classified as other income is a huge amount and can act as a deterrent for many investors. Startups in the angel round of investing need the money as survival will be crucial. In a way, the tax itself kills any new innovation.

Other tax benefits for startups

In January, during the Startup India Standup India event, the government announced that profits of startups set up after April 2016 will be exempt from income tax for a period of three years.

In addition, investments made by incubators shall be exempt from tax in startups who are valued higher than the market value. An exemption shall also be given to capital gains for monies in the Fund of Funds recognized by the government.

Image credit: Flickr user Phillip Ingham under CCBY 2.0