Foreign angels – trouble in Indian paradise?

2023-04-21 11:15:29

Widening the scope of angel tax to money raised from non-resident investors has been one of the most discussed aspects of this year’s Union Budget. A provision which was introduced in 2012 with the original objective to tax unaccounted money finding its way back into the system through share issuances at unusual premiums, has been used by the income tax authorities to raise demands on start-ups raising capital at valuations unheard of in traditional business models so far.

Hitherto, capital raised from non-resident investors and from domestic AIFs or VC funds was exempt from the ambit of angel tax.

Removal of the exemption for non-residents while retaining it for domestic AIFs has now created an unequal playing field for funds which are domiciled offshore such as in Singapore or Mauritius. Even money infused by foreign companies in their Indian subsidiaries is under the scanner now.

It is imperative to note that the angel tax provisions are specifically exempted for recognised start-ups not having completed ten years from incorporation meeting specified criteria. These criteria, inter alia, include aggregate share capital and premium not exceeding INR 25 crores and turnover not exceeding INR 100 crores.

Given the financial thresholds, currently the benefits are available only to a select number of smaller new start-ups.

With global liquidity squeeze leading to the onset of the funding winter for Indian start-ups, raising capital has become quite challenging. Amidst such times, an onerous tax provision such as angel tax is likely to further dent the ability of Indian start-ups to raise capital at good valuations.

While the FEMA Regulations permit an Indian company to raise capital from foreign investors at or above the fair market value of the shares, one can now expect heightened negotiations and discussions on valuations and indemnities as foreign investors would want to factor the risk of an angel tax related litigation on valuations and returns. The tax department has litigated on fair market values where the actual future performance has been at a deviation from that projected at the time of the fund raise. The strength and credibility of the valuation exercise assumes even more significance against this backdrop.

While the jury is still out on whether this move will push Indian start-ups to offshore ownership structures or prompt more foreign venture capital funds to float domestic AIFs to participate in the India growth story, indications from the DPIIT to consider relaxations in some of these provisions in consultation with the Ministry of Finance certainly is a gleam of hope for the Indian start-up community.

Exempting funds raised from SEBI registered foreign portfolio investors or from foreign VC funds managed by licensed fund managers, will help bring capital raising from professional domestic and foreign investors at par. Similarly, exemption for funds raised from companies listed on overseas stock exchanges should be actively considered. Additionally, it may be prudent to consider providing for tolerance limits to enable raising funds from foreign investors at higher than fair market value as permitted by the FEMA Regulations.

Raising the turnover and capital related exemption thresholds for DPIIT recognised start-ups will also provide a shot in the arm for some of these businesses where access to capital flows is crucial for long term sustainability and value creation.

Whether the industry expectations will be duly considered by the Government remains to be seen but some of the above relaxations will surely go a long way in helping Indian businesses raise growth capital in tough times such as these.

(The authors, Vaibhav is a Partner and Pooja is a Principal at Dhruva Advisors LLP. The views are personal.)

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