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Harry Parikh, Partner/ M&A Tax and Regulatory
Deal Advisory Services

03 February 2023

If the funding winter was not enough of a problem, the government has thrown another curveball at startups with its Union Budget 2023. According to experts, a new tax provision could severely dent startup investments in the country by foreign investors such as SoftBank, Tiger Global, Alpha Wave and Sequoia.

This is because an exemption for money raised from foreign investors under the so-called angel tax regime has been done away with in the Finance Bill, 2023. However, the exemption for investments made by SEBI-registered alternative investment funds still continues.

“In contrast to the encouragement for reverse-flipping in the Economic Survey, this move will also prompt more start-ups to shift their domiciles to foreign countries,” said Siddarth Pai, managing partner of VC firm 3One4 Capital.

But, the biggest concern is that it will become an impediment for some of the biggest foreign investors into Indian startups. An analysis of the funding rounds from 2022 and 2021 shows Indian investment at low single digits in these rounds. Placing these restrictions on foreign capital without any exceptions will be detrimental to startup funding” he added.

The angel tax regime was originally started in 2012 as an anti-abuse measure to prevent money laundering. It mandated that a startup’s fundraise could be taxed whenever the funding round happened at a valuation more than the fair value of shares – as determined by a merchant banker.

According to Suraj Malik, a management consultant who advises family offices, today’s move was to bring parity with investments made by resident investors and to ensure that no tax evasion is possible even in case of investment from outside India.

Over the years, startups and investors have raised an alarm about being troubled by the taxmen due to the provision even in the case of genuine investments.

According to Harry Parikh, Partner at tax, accounting and advisory firm BDO India, the inclusion of foreign investors in the angel tax provision will not only increase the compliance burden on startups, but also cause confusion in fundraises where valuations are not strictly defined.

“Start-ups also raise funding in the form of convertible instruments where the valuation is not fixed until the next round…Such rounds will become challenging to execute from a regulatory standpoint,” he said

fter years of startups crying themselves hoarse, the government made a concession in 2019 that DPIIT-registered start-ups would be exempted from the provision. But, the fine print showed that it was not a blanket exemption for all such start-ups. It applied only to those certified by another government body called Inter-Ministerial Board (IMB).

Pai of 3One4 said, “The IMB is a group of bureaucrats who need to certify that a startup is innovative and worthy of receiving benefits under the Income Tax Act, 1961. Out of the 84,000 startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT) as of date, less than 1 percent are IMB certified.”

Source: Moneycontrol