Angel investors not cheering tax exemption, reluctant to share bank details

Certification process is tedious and will increase costs for start-ups

The exemption from tax may not boost angel investment in start-ups as investors find the new rules still restrictive.

The new rules require start-ups to get valuation certificate from merchant bankers, instead of a chartered accountants earlier; the deal also needs to be certified by an inter-ministerial board (IMB). These will be time-consuming and expensive for start-ups, say investors.

Last week, the Income Tax Department exempted start-ups from tax on investments they receive from angel investors above their fair valuation. The tax was being levied on companies issuing shares to investors above their fair value, treating them as other income. 

VCs and foreign investors are exempted from the tax, and the same is being extended to angel investors now. The relaxation comes with riders and is subject to certifications and angels meeting the eligibility norm. 

Angels are not enthused and still have some concerns. 

AREAS OF CONCERN

• Certification process time-consuming, expensive for start-ups
   
• Merchant bankers ill-suited to value early-stage start-ups
   
• Fund-raising is not a taxable event but a capital-raising one
   
• Angels not keen to share KYC, bank details before investing 
   
• Criteria for angel is only financial, doesn’t value experience

‘’It is an ill-thought regulation so there’s a lot of band-aid treatment. IMB certification, merchant banker valuation is a time consuming and expensive process,’’ says an angel investor who has backed over 40 start-ups. ‘’What they are taxing is not a taxable event, but a fund-raising event. No one is making money here,’’ he adds.

“The tax itself was bizarre given many other countries go out of the way to encourage start-ups by allowing tax breaks and incentives for angel investing and not penalise. India should go one step ahead by giving 80G-type tax incentive for investing in qualified start-ups,’’ says K Ganesh, an entrepreneur-turned-angel investor.  

“How can a merchant banker with no domain knowledge value a start-up, which is disruptive? Most often investors put in money at a pre-revenue stage, based on the potential of a firm,’’ says Padmaja Ruparel, co-founder, Indian Angel Network. 

“The whole process (certifications, KYC norms) is tedious and start-ups will find it difficult to raise money from angels. This is not going to encourage start-up investments. Which investor will share his KYC, bank accounts details with a firm it has not invested yet? she says.

Investors say there is an inconsistency under Companies Act (registered valuer rules) and the income tax amendment. “The registered valuer under Companies Act should be covered under the IT Act,’’ says Apoorv Sharma, co-founder, Venture Capitalists.

The definition of accredited angel investor should be revisited to include experience of the investor as well. Current criteria covers only the financial background and not the experience which is crucial in building early stage start-ups. “The authorities should understand that angel investor is a start-up builder not just an investor,’’ he says.

“The vexatious and retrogade  angel tax issue does not seem to go away but like a persistent virus keeps nagging the startup ecosystem  While well intentioned, it is two steps forward and one step back every time,’’ adds Ganesh, who has backed several start-ups. 

He feels the government should just cancel it. It’s wrong on many counts to levy tax on a fundraise or funding event. It’s an investment and not a monetisation or liquidity event where someone is gaining or making profits that can be taxed, he says. Secondly, valuing start-ups is an art, with huge risks and uncertainties, and 90 per cent of the times the Entrepreneurs and investors get it wrong. 

“Merchant bankers are ill suited to value early-stage start-ups especially at angel investment stage. Merchant bankers are used at IPO stage, late growth stage when there is more certainty about the business, underlying business models and market scenario in terms of sector attractiveness, growth, competition etc,’’ says Ganesh.

The entrepreneur’s life just become tougher now as in addition to convincing investor, convincing customer, he needs to convince a merchant banker too about the valuation.