The central government has abolished the angel tax, a significant move expected to end the funding winter for startups and attract substantial foreign investment. This decision, announced in the Union Budget 2024-25, aims to simplify the investment process and bolster India’s startup ecosystem, currently the third largest in the world.
The angel tax, which imposed an income tax of over 30% on funding raised by unlisted companies or startups if their valuation exceeded the company’s fair market value, was widely criticised for hindering investment. This tax was viewed as a barrier to investment, as it targeted investments rather than income, discouraging investors from supporting innovative ideas in India. Consequently, many startups sought funding from foreign investors, resulting in a decline in foreign direct investment (FDI) within the country.
With the removal of the angel tax, the startup ecosystem is expected to see an influx of venture capitalists, high net worth individuals, and foreign investors who were previously deterred by the compliance burden. The decision is anticipated to improve the pipeline of funds and end the funding winter affecting startups.
This abolition also aims to reduce disputes and litigation, providing tax certainty and policy stability. The move is particularly beneficial for emerging sectors such as deeptech, artificial intelligence, and clean energy, which require significant early-stage capital.
Tax blues
Previously, Section 56(2)(viib) of the Income Tax Act deemed any amount raised by a startup in excess of its fair market value as income from other sources, subjecting it to a 30% tax. Despite several amendments to make the tax regime more investor-friendly, the provisions were still seen as an obstacle to the industry’s growth.
The government’s decision followed extensive feedback from stakeholders and an analysis of international approaches to similar tax regimes. The Department for Promotion of Industry and Internal Trade (DPIIT) acknowledged that the angel tax was negatively impacting the growth of the startup ecosystem, particularly inbound investments.
The abolition of the angel tax is expected to infuse confidence into the investor community, increasing the number of active investors in India and fostering an environment conducive to innovation and economic growth. As of now, approximately 1.44 lakh startups are recognized by the DPIIT, and this move is poised to significantly enhance their ability to raise funds domestically.
