2024 Indian Budget Report
- nipunkapur5678
- Oct 26, 2024
- 8 min read
Updated: Jan 19
Introduction:
The 2024 Indian Budget has introduced several measures aimed at boosting the country's economic growth. This report focuses on its implications for the startup ecosystem, particularly the abolishment of the angel tax, which has been a significant pain point for early-stage companies seeking funding. Additionally, it will cover various budget allocations relevant to startups.
Overview of the Budget:
Abolition of the Angel Tax
One of the most impactful changes introduced in the 2024 Indian Budget is the abolition of the angel tax for all classes of investors. The angel tax, previously levied on the excess capital raised by startups over their fair market value, often deterred investment and created financial and administrative burdens for startups. Its removal is expected to significantly boost the investment landscape for early-stage companies, encouraging more angel investors to participate in the funding ecosystem without the fear of additional tax liabilities.
Support for Startups
The budget has allocated substantial funds to support the startup ecosystem, emphasizing innovation and entrepreneurship. Key allocations include:
₹1,000 Crore Venture Capital Fund for Space Economy: This fund aims to expand India's space economy by five times over the next ten years, fostering innovation and growth in this high-potential sector.
Increased Limit for MUDRA Loans: The limit for MUDRA (Micro Units Development and Refinance Agency) loans has been enhanced from ₹10 lakh to ₹20 lakh, providing more substantial financial support to micro and small enterprises, including startups.
Implications for Early-Stage Companies
The abolition of the angel tax and the significant budget allocations are expected to have several positive impacts on early-stage companies:
Increased Investment: With the removal of the angel tax, there is likely to be a surge in angel investments, providing startups with the necessary capital to scale their operations and innovate.
Enhanced Financial Support: The increased limits for MUDRA loans and other financial provisions will provide startups with greater access to funding, reducing their reliance on traditional lending institutions.
Improved Infrastructure: Investments in rural development and agriculture will create better market conditions for startups operating in these sectors, facilitating growth and expansion.
Angel Tax:
To operate an early-stage venture, every business needs funds. In this scenario, startups seek investment in exchange for equity because they lack tangible assets to offer as collateral. When a startup struggles to establish itself in the market, an angel investor can invest money in it.
The Income Tax Act of 1961 addresses the issue of the angel tax. According to the Finance Act of 2012, in the IT Act, any startup (i.e., unlisted companies whose shares are not available for purchase on the stock market) that obtains investment from an angel investor is required to pay a set sum to the government.
First introduced in 2012, by then finance minister Pranab Mukherjee, Section 56 (2) (viib) of the Income Tax Act-- known as angel tax-- is applicable on any amount received by a privately held company against sale of its shares at a price higher than its fair market value. The differential amount is treated as income and taxed at a rate of around 31%.
However, this tax applies if the overall investment worth exceeds the company's FMV, or Fair Market worth. Investments greater than FMV are classified as "income from other sources," and the tax imposed on them is known as the angel tax.
The major goal of this tax was to combat money laundering. Only 2% of the population meets tax requirements. Most new enterprises fail to maintain proper accounting records or accurately display their assets, resulting in the emergence of black money in India. Because of this issue, the Income Tax Department decided to tax private corporations on excess share premiums collected beyond fair market value.
Drawbacks of the Angel Tax
Angel tax applies to startups backed by a resident Indian.
A startup that receives venture funding or investment from non-resident investors is ineligible for the angel tax deduction.
Startups often lose a considerable amount of money due to taxes, as angel tax requires them to share a big portion of the investment.
Angel Tax Exemptions
As previously stated, the angel tax causes a startup to lose a considerable percentage of its funding. Most firms cannot afford to lose this much money, especially at the early stage. The inclusion of this tax in the amendment has sparked widespread criticism from investors, entrepreneurs, and industry professionals.
Following several requests from startups, the Indian government included various relaxations in the 2019 Union Budget. In this budget, the government said that if the startup is registered with the DPIIT or the Department for Promotion of Industry and Internal Trade, it will not be liable to this tax.
To be qualified for DPIIT, the startup must submit an application along with the required documentation to the Central Board of Direct Taxes, or CBDT. Following CBDT clearance, they will be exempt from paying angel tax.
Aside from that, a startup must meet several other conditions in order to file the proper declaration and returns for angel tax exemption. Here's a quick overview.
After issuing the shares, the startup's total paid-up capital and share premium should not exceed Rs 25 crore.
According to Rule 11 UA (2)(b) of the Income Tax Act of 1961, the merchant banker must examine the startup's fair market value.
The sum raised by venture capital firms, NRIs, and other specific companies is not factored into the computation. The startup's annual turnover should not exceed Rs 100 crore in any of the previous fiscal years.
According to the income tax notification, angel investors are eligible for a 100% tax break when investing in firms with a higher fair market value. To be eligible for this exemption, angel investors must have an average income of no more than Rs 25 lakh and a net worth of Rs 2 crore in the previous three fiscal years.
A business can benefit from a three-year tax vacation beginning with its incorporation date. During this time, the startup is exempt from paying taxes.
The main issues
Since its inception, the interpretation of these laws has been the subject of numerous discussions among corporations, as various parts remain ambiguous, resulting in problems. This is hastened by Indian tax authorities rejecting the taxpayer's assessment methodology and taking a different viewpoint that goes beyond the meaning of the legislation. A few issues include:
The failure of provisions to differentiate between legitimate investments and money laundering activities;
The tax officer rejecting the valuation methodology and undertaking a fresh evaluation.
Disparity with valuations prescribed under Foreign Direct Investment Regulations;
Valuation issues in the case of issuance of shares by an Indian company in a distressed situation, right issues, bonus issues, amalgamation/demerger, etc.
Applicability at the time of conversion of convertible instruments into equity, etc.
The Latest Update
Budget 2024 now proposes eliminating the angel tax for all kinds of investors beginning in fiscal year 2025-26 (April 1, 2024; Financial Year 2024-25). Although specific changes have been made to section 56(2)(viib), no changes have been made to the definition of 'income' under section 2(24)(xvi). This appears to be an oversight, and clarification on this point is expected.
Nevertheless, this move certainly addresses the above-highlighted issues. Having said that, to further make an investment in a start-up a viable option, the Government may also seek to cater to the following issues:
Given the potential annulment of the angel tax laws, resolving existing legal conflicts requires careful attention.
Relief from litigation for verifying the source of income of an investment to the satisfaction of tax officers under Section 68.
The proposal in Finance Bill 2024 to totally repeal the angel tax provision for all investor classes will provide a much-needed respite to the Indian start-up ecosystem and spur a new infusion of capital into the economy.Making reforms to the legal framework will provide predictability while also allowing Indian startups to thrive and spread. There are still many aspects to figure out to encourage new companies, and adopting certain regulatory adjustments in this area might significantly improve the entire environment.
Challenges and Considerations Post-Abolition of Angel Tax
While the abolition of the angel tax is a welcome change, the startup ecosystem must also navigate several challenges to fully capitalize on this development. One key issue lies in the valuation of startups, which remains a subjective and often contentious area. The lack of standardized valuation metrics for startups can lead to discrepancies, particularly when tax authorities and investors have differing views on a company’s fair market value. This ambiguity could result in future disputes unless clear guidelines are established.
Another consideration is the potential impact of this policy change on foreign investments. With the angel tax abolished, there may be an influx of foreign capital into the Indian startup ecosystem. While this is generally positive, it also raises concerns about the potential for increased control by foreign investors over Indian startups. This could lead to a shift in strategic decisions that might not always align with the local context or the long-term vision of the company’s founders. Balancing the benefits of foreign investment with the need to maintain control and preserve the unique identity of Indian startups will be a critical task moving forward.
Further Government Initiatives to Support Startups
In addition to the removal of the angel tax, the 2024 Budget outlines several other initiatives aimed at fostering the growth of startups. The government’s focus on enhancing digital infrastructure and promoting technological innovation is particularly noteworthy. By investing in digital public goods, such as broadband and 5G networks, the government aims to create an environment where startups can thrive in the digital economy. This investment in infrastructure is expected to reduce barriers to entry, enabling startups to reach broader markets and scale more rapidly.
Moreover, the budget's emphasis on research and development (R&D) incentives is set to play a pivotal role in nurturing innovation. By providing tax credits and subsidies for R&D activities, the government is encouraging startups to invest in new technologies and develop cutting-edge solutions. This support is crucial for startups operating in high-tech sectors such as biotechnology, artificial intelligence, and clean energy, where significant upfront investment in research is often required.
Sector-Specific Impacts
The impact of the 2024 Budget will vary across different sectors within the startup ecosystem. For instance, the allocation of funds to the space economy through the ₹1000 crore Venture Capital Fund is likely to stimulate growth in space tech startups. This initiative aligns with India’s broader ambitions in the global space race and provides startups with the financial backing needed to innovate in this capital-intensive sector.
Similarly, the increase in MUDRA loan limits will have a profound impact on micro and small enterprises, particularly in the agriculture and rural development sectors. Startups in these areas often face challenges in accessing traditional forms of credit due to their size and the perceived risks associated with their operations. By increasing the loan limits, the government is providing these startups with a vital source of capital that can be used to invest in new technologies, expand their operations, and ultimately contribute to the rural economy’s modernization.
Conclusion
The 2024 Indian Budget marks a significant turning point for the startup ecosystem. The abolition of the angel tax, coupled with strategic budget allocations, provides a much-needed boost to early-stage companies seeking funding. However, the success of these initiatives will depend on the effective implementation of the policies and the ability of startups to navigate the associated challenges. By fostering a supportive environment and addressing the remaining regulatory uncertainties, the Indian government has the opportunity to transform the startup landscape, making it more conducive to innovation and sustainable growth.
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