What is Angel Tax
Start-ups need capital to fund their growing business prospects. To meet such requirements, they raise funds from angel investors. However, the funding raised from angel investors at a higher valuation is not tax-free as per the Income Tax Act and attracts angel tax.
In this blog, we will delve into the concept of angel tax while highlighting the relevant details that you need to know.
What is Angel Tax Meaning
Simply put, angel tax refers to the income tax payable on the funds raised by unlisted companies from angel investors. Many unlisted companies have strong profitability and promising business prospects, making them attractive to angel investors who are willing to purchase stakes at a higher valuation.
When these companies raise funds at a valuation above their fair market value, the excess amount is considered ‘Income from Other Sources’ and is subject to angel tax.
Note that the angel tax has been abolished with effect from FY 2025-26 as declared by the finance minister in the Union Budget 2024. This was mainly to encourage all classes of businesses and start-ups to strengthen India's start-up ecosystem and economy.
Angel Tax Rates
Angel Tax in India is levied at a 30% interest rate, and a 3% additional cess is also applicable as per Section 56(2)(vii)(b) of the IT Act. Thus, the combined effective rate of angel tax is 30.9%.
Note that this rate will be abolished going forward in the financial year 2025-26.
Angel Tax Exemption
Previously, the angel tax was levied under Section 56(2)(vii)(b) on the entire amount. However, the government has come up with several conditions, and meeting those will help investors get an exemption from paying angel tax.
These conditions are as follows:
- The start-up must be recognised by the Department of Promotion of Industry and Internal Trade (DPIIT).
- The start-up must not invest in jewellery, land, buildings, capital investment in any other organisation, any transportation means costing more than Rs 10 lakh, or loan advancements.
- A certified merchant banker must determine the valuation and its fair market value.
- The start-up must have a total paid-up capital of less than or equivalent to ₹25 crore.
Angel Tax Applicability
The tax authorities charge angel tax on the premium earned by start-ups. They calculate and tax the difference between the face value of the shares issued and their actual value at the applicable rate.
Let us understand the same with the help of an example:
For instance, a beverage start-up receives funding of ₹20 crore. However, the company's fair value is ₹12 crore, while the remaining ₹8 crore is the premium investors are willing to pay for the stake in the beverage start-up. Hence, the angel tax will be applicable to this ₹8 crore, which is the premium amount instead of the entire amount of funding received.
The Bottomline
To wrap up, the government levies an angel tax on the capital raised by start-ups, specifically on the excess amount raised above the business's fair market value. An effective rate of 30.9% is applicable to this amount. However, this rate will be abolished in the financial year 2025-26.