Angel investment tax: Tax laws, Tax benefits for angel investors, Tax Exemptions

Angel investors in India who fund startup ideas can avail of tax benefits under various sections of the Income Tax Act.

Angel investors are high net-worth individuals who offer financial security, funding, or backup to newly launched businesses like startups. In return, they hold the ownership of part of the business’s equity.

Angel funding can be a one-time bulk investment as the business’s initial capital, or it can be over a long period of time to sustain the business. Although investing in a startup or an entrepreneurship venture is highly risky, it also comes with a higher rate of return than conventional investment alternatives.

Angel investors can be business professionals like doctors and accountants, C-level company executives, successful business owners, or even users of crowdfunding platforms. They approach young businesses or startup ideas via industry seminars, commerce meetings, or online platforms. The investors then thoroughly understand the project idea, review the drafts and documents, take referrals about the founders, and realise the regulations involved. 

Once the deal is done, the investment is made, and the angel investors usually hold on to 25%-30% equity share.

Income tax laws and rules for angel investors in India

Over the past few years, India has seen rapid growth of successful entrepreneurship and angel investment opportunities. This introduced the term ‘Angel Tax’, which defined the income tax payable by unlisted companies through the issue of shares over transactions held off-market. However, this tax is applicable only when the angel investor earns an income. Hence, it is applied on the capital raised only if the price of the issued shares exceeds the fair market value of the business by a significant amount.

Angel Tax, regulated by the Securities and Exchange Board of India (SEBI), is based on Section 56(2)(viib) of the Income Tax Act 1961. It was introduced in 2012 as Section 56(2)(viib) of the IT Act under the main Finance Act. Note that it is levied only on resident investors and not non-resident or venture capital investors.

The following are the income tax rules on angel investments in India: 

• The investment amount must be strictly between INR 25 lakh and INR 5 crore.
• The investment must not exceed 25% of the sum total investment made.
• The investment will see a lock-in period of 3 years.
• Investors are not allowed to invest funds into associates.
• The turnover of the startup or business must be less than INR 25 crore.

In context, the recipient party cannot be sponsored by any industrial group with a turnover valuation of more than INR 300 crore.

However, the good part is that angel investors in India are eligible for income tax benefits and exemptions. Tax benefits are government-offered reductions in otherwise high income tax amounts. This is usually done to encourage more people to participate in such activities for the better good. Angel taxes also come with income tax benefits and exemptions.

The criteria that the startup must meet are as follows:

• The upper limit for the paid-up capital and the share premium of the startup, after issuing the shares, is INR 10 crore.
• The fair market value of the startup must have been certified by a merchant banker as instructed by the Rule 11 UA (2)(b) of the Income Tax Act of 1961.
• The minimum net worth of the angel investor should be INR 2 crore.
• The average income of the angel investor as calculated for the past 3 financial years should be over INR 50 lakh.

If the startup and angel investor want to apply for income tax exemptions, they need to receive approval from an 8-member inter-ministerial board under the Department of Industrial Policy & Promotion (DIPP). The application for the same will then be sent to the Central Board of Direct Taxes (CBDT) for approval.

The following are the income tax benefits that angel investors can avail of:

Section 56(2)(viib)

Typically, angel investors are eligible for angel tax exemption under Section 56(2)(viib) of the Income Tax Act. It means that they will have to pay taxes only on that amount by which the sum total received from the issues of the startup’s shares overtakes the fair market value. This taxable difference will be registered as an “income from other sources”. However, the comprehensive sum of the paid-up share capital and the share premium of the startup must be contained within INR 25 crore for this rule of exemption to be enforced.

Section 79

Another provision that angel investors can benefit from is Section 79 from the same Act, which provides for the previous year’s losses to be set off before the current financial year and not carried forward. Such an arrangement came into force to prevent fraud taxpayers from displaying a fake loss-forefront to their business to win tax benefits while still generating profits in the backend. It safeguards angel investors because it is applicable only when the substantial ownership of the company goes to someone within the same group.

Section 54GB

Likewise, Section 54GB of the Act calls for exempting the investors from the capital gain on the transfer of a residential plot under the condition that they have invested that amount in the equity shares of a startup.

Section 80-IAC

Under Section 80-IAC of the IT Act, tax deduction rules state that deductions will be given at 100% on its gains for 3 out of 7 successive assessment years. Angel investors can also gain access to CBDT’s special cell devoted to solving startup issues.

Related: Exploring new beginnings and comebacks in the stock market

Advice for aspiring investors

If you are looking for opportunities to become a professional angel investor, keep in mind that angel tax is levied at a heavy rate of 30.9% on excess investments (over the fair share market value). However, the average internal rate of returns on investment (ROI) is 22%, indicating that there is significant profitability in this domain.

Before you jump into investing in a startup venture, back up your finances with a robust exit strategy, acquisitions, or even IPOs as shock absorbers. Get familiar with the rules and regulations involved, and ensure that your project satisfies all the listed criteria. India has become a startup hub and is the third-largest startup ecosystem in the world; see how you can reap benefits by becoming an angel investor