Union Budget 2024-25: Govt abolishes angel tax on startup funding

Capital gains tax rates between listed, unlisted equity aligned

Tax benefits have been announced for startups and their investors, such as scrapping the contentious angel tax for all classes of investors and aligning capital gains tax rates for listed equity with those for unlisted equity.

Angel tax, officially Section 56(2) (viib) in the Income Tax Act, applies to unlisted companies when they raise capital by issuing shares to investors at a price exceeding its fair market value. The excess amount is treated as income and taxed at 30.9 per cent.

“To bolster the Indian startup ecosystem, boost the entrepreneurial spirit, and support innovation, I propose to abolish the so-called angel tax for all classes of investors,” said Union Finance Minister Nirmala Sitharaman in her Budget speech on Tuesday.

Angel tax aside, the Budget has cut the long-term capital gains tax rate for financial assets to 12.50 per cent from 20 per cent.

The angel-tax move has been hailed by startups and investors.

“This breathes a new life into the startup ecosystem. This forward-thinking move by the government eradicates a significant compliance burden, attracting investment and fostering an environment where startups can truly thrive,” said Adarsh Nahata, chief financial officer (CFO), PhonePe.

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According to Siddarth Pai, founding partner of early-stage venture capital fund 3one4 Capital, the removal of the tax is a major win for investors.

“Companies raising capital from April 1, 2024, onwards won’t have to suffer the threat of angel tax. The extension of ‘angel tax’ to foreign investors resulted in a massive drip in funding,” he said.

In 2023, the funding of startups fell 72 per cent year-on-year (Y-o-Y) to a seven-year low of $7 billion compared to $25 billion in the previous year, said Tracxn, a market-intelligence platform.

The move is expected to make it easier for investors to complete transactions faster and streamline investment.

“Previously the requirement for income-tax officers to understand and assess valuations led to conflicts and delays, involving chartered accountants, valuers, and tax officials. Valuation assessments were never meant to fall within the remit of income-tax officers, and this change eliminates those complications,” said Anirudh A Damani, managing partner, Artha Venture Fund.

Introduced in 2012, angel tax aimed to prevent tax avoidance and fund misuse. It is so called because it significantly affects angel investment in startups. It was initially applicable to local resident investors but its ambit was expanded as part of the government’s anti-tax avoidance move.

“Reduction in the long-term capital gains tax rate would result in an significant increase in post-tax internal rate of return for domestic limited partners and carried interest for general partners of Category I and II alternative investment funds,” Nishchal Joshipura, lead, corporate and mergers and acquisitions, Nishith Desai Associates.

Investors say the differential tax rates were cause for concern, leading to investment in listed companies and not unlisted ones.

“Investment in unlisted companies goes into asset creation, hiring, and sales. Aligning tax rates recognises this contribution and will result in more funding to Indian startups,” said Pai.

To give a fillip to the emerging space technology sector in India, the Budget has announced a proposal to set up a Rs 1,000 crore venture capital fund for the space economy.

“With our continued emphasis on expanding the space economy by five times in the next 10 years, a venture capital fund of Rs 1,000 crore will be set up,” the finance minister said.