Angel Tax is not the only menace
By BackUPStories - February 14, 2019
The problem with Travel Khana and Babygogo is not just about Section 56 (2 vii b), better known as Angel Tax. The two saw action initiated under Section 68 of the Income Tax Act, 1961, as well.
Siddarth Pai, Founding Partner, 3one4 Capital, sheds light on the issue, and Section 68, which talks about unexplained cash credits. He says the section states that if a startup or a private limited company has any credits, including any share premium or share capital, the receiver needs to establish the identity and creditworthiness of the investor.
Section 68 is an anti-abuse measure, and unlike Section 56 (2 vii b), doesn’t talk about valuation.
“In the case of Travel Khana, they got a notice under this section. The problem here is that the assessing officer makes the startup founder the intermediary between them and the investor. They ask the startup to share three kinds of documents to establish identity and creditworthiness – investors’ bank statement, financial statements, and income tax returns,” says Siddarth.
However, startups and investors alike say this information is confidential and not shared with a startup founder.
Caught between a rock and a hard place
Siddarth says the government needs to change its stance here and that a startup only needs to give basic information about the investor to the assessing officer. It should then be the IT officer’s job to get the investment details directly from the investor.
In Travel Khana’s case, the CBDT says it had sent several notices to the founders seeking details of the investors and their bank details. In response, Pushpinder says,
“There were no ‘cash’ transactions. Section 68 of IT Act is being applied on us, which is designed against “unexplained” cash deposits. Each transaction came through bank transfers or equivalent. Each of our investors is valid, with bonafides authenticated, and we raised the funds from Letsventure.com (LV). LV is a reputed and respected platform for Angel investments. Additionally, many of our investors in the round mentioned are highly respected public figures.”
While the government is making moves to salvage the situation, one of the biggest concerns for startup founders now is - Is this the environment I want to build my startup in?
Shanti Mohan, Founder, LetsVenture, which is one of the key investors in Travel Khana says,
“The department should provide enough time for appeal and take action only if there are serious financial irregularities. While the DIPP (now DPIIT) has been in conversation with the various stakeholders, there should have been a stay on such coercive measures to the startups.”
A founder in Bengaluru, seeking anonymity, says seeking details from investors puts them in a fix. “The investors are not obliged to share any of their bank transaction details with us. At best, we can share the name, contact details, and PAN details of the investor with tax officials. After that, the ball is in their court. If they deduct money from our account, it is big hit to our businesses.”
The problem is that the guidelines around such taxation has never really been clear, and despite repeated assurances, startup founders are still being penalised.
“It is like being caught at both ends. We have Angel Tax on one side, where we need to validate valuation and investments, and then Section 68. Can there be more clarity of what is expected from a founder?” a Bengaluru-based startup founder told YourStory on condition of anonymity.
Indruj Rai, Partner at law firm Khaitan & Co, believes there is a different problem at play here.
“The government doesn’t want to do away with Angel Tax. There have been some submissions made to do away with the tax since there is already Section 68, which says a company (including startups) should be able to prove the genuineness of the source of investments received and also prove genuineness of source of such money in the investor’s hands.”
As Siddarth points out, “Section 56 (2 vii b) says if you are a private limited company issuing shares at a premium, the difference between the price at which you issued the shares and the fair market value of the share is taxed as income in your hands.”
He says, two types of investments, though, are excluded – SEBI-listed VC funds and investment from a non-resident. DTIPP-registered startups are also currently exempt. Unfortunately, not all startups are DPIIT registered, and not everyone gets funded from SEBI-listed VC funds.
To address this, LetsVenture recently launched an Angel Fund (subcategory of cat-I VCF, which is regulated by SEBI) – a vehicle through which all its investments are routed. “The Angel Fund prevents the startups from getting hit by the Angel Tax issue (which was one of the key reasons for us to start the fund),” says Shanti.
For others, Indruj advsises,
“My advice to startups would be to get registered by DTIPP nonetheless. Further, when startups get a scrutiny notice asking for more information on a certain transaction, the first time, they should provide enough documentation with a case well represented by an external counsel.”
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