Seven months after the tax department “relaxed” the valuation methods for non-resident capital infusion in start-ups to address their concerns over having to pay “angel tax,” the tax heat on them has only risen. According to industry sources and tax experts, many start-ups have already moved court and more are planning to, challenging the tax demands, and way the taxman seeks to “alter” or differ with the valuation methods followed by the firms.
The start-ups are also armed with several tribunal and court rulings of the past where it was held that the taxman has no right to change the valuation arrived at by the taxpayer or by the third part valuer on his behalf, so far as these follow the options notified, the sources added.
Over 100 are facing tax demands running into hundreds of crores under the angel tax provisions, said the sources.
There are also cases where the firms’ freedom to chose among the valuation methods are challenged by the taxman. “In one case, a start-up chose the NAV (net asset value) method for valuation, but tax authorities said why did it not choose the DCF (discounted cash flow) method, as it is a new entity, and didn’t have a historical value of assets,” a source said.
NAV represents the current worth of an asset, whereas DCF is a financial model that assumes perpetual growth for a company. NAV is determined by subtracting a company’s liabilities from its assets and is typically close to the book value of the business. DCF, on the other hand, is built on the concept that an asset’s value is influenced by its future cash flows and residual value upon sale.
Angel tax – a tax levied at the applicable corporate tax rate– is imposed when an unlisted company issues shares to an investor at a price higher than its fair market value (FMV), or at premium. Earlier, it was imposed only on investments made by a resident investor. However the Finance Act 2023 proposed extended angel tax even to non-resident investors from April 1, and five valuation principles were subsequently notified to give the firms a higher leeway and more options to chose from.
In addition to the NAV and DCF methods that existed previously, the Central Board of Direct Taxes (CBDT) in September last year notified five more valuation methods for non-resident capital infusion in Indian unlisted firms – comparable company multiple, probability weighted expected return, option pricing, milestone analysis and replacement cost.
“The tax rules don’t mandate start-ups to chose any specific method for valuing the investments, it is at the option of the start-ups to chose a valuation method. There has been a lot of precedence available on the fact that the option given to taxpayer (to choose) cannot be read as available to the tax authorities,” said Yeeshu Sehgal, head of tax markets at AKM Global. Sources cited the Delhi I-T tribunal’s 2023 ruling favouring Gamma Pizzakraft (Overseas) to cite the legal position.
Angel tax is typically a tax levied by stating that a particular fund infusion is “income” rather than capital to the firm concerned, to the extent it exceeds the fair market value of the shares. It has emerged as a major concern for the Indian startup community, particularly those in the early stages of development with limited revenues, as it constricts their cash flows. It also reduces the capital raised, hindering their expansion plans.
“Determining the fair market value of a startup, especially in its early stage, is challenging due to limited financial data, leading to disputes with tax authorities, resulting in prolonged assessments and unnecessary burdens,” said Yogesh Kale, Executive Director, Nangia Andersen India.
“The potential of more litigation around angel tax creates uncertainty for investors, discouraging them from funding startups and limiting capital availability,” he said.
Mitesh Jain, Partner at Economic Laws Practice says litigation could be problematic for start-ups considering that they may be required to pay 20% of the disputed demand upfront, even as case is pending.
Jain suggests that the government should streamline the provisions of angel tax further to make it simpler and less complex. “The threshold limits/conditions for recognising an entity as an ‘start-up’ for providing exemption from angel tax provisions may be increased/eased,” he says.
Currently some startups recognised by the Department of Industrial Policy and Promotion are exempted from the angel tax provisions. Startups exempted from paying the tax are those where the aggregate amount of paid up share capital and share premium of the startup after the proposed issue of shares does not exceed Rs 10 crore. Any startup which has raised money in the past or/and which has a proposed investment within the above limits can apply for this exemption.
Punit Shah, partner, Dhruva Advisors says: “The angel tax is an anti-avoidance provision and should be applied only in the situation of suspected tax avoidance. It should not be applied to all cases where start-ups have received share premium amounts.” Shah says the finance ministry would do well to exempt startups from the angel tax provisions for receipt of at least overseas funds which are anyway regulated in their home countries.
Please click here to view the full story on Financial Express.