Posted by The TaxAdvocate Group, LLC

Angel Investor Tax Chaos Among Startups

Angel Investor Tax Chaos Among Startups

To promote economic development and create more jobs, the Government has encouraged a startup movement. The goal is to bring innovative ideas to the platform and secure funding from the Government or other angel investor networks to train more first-generation entrepreneurs. Tax concessions were also announced through a talent recruitment process to move in this direction. Any new move is usually problematic in the compliance of angel tax and is widely covered by the media as it is seen as a blow to the original movement.

The new regime has fostered innovation and entrepreneurship as part of a launching mission, as these new-era businesses have the potential to create jobs. These startups are a way for angel investors to take them forward. Angel investing usually comes with a premium valuation based on a futuristic earnings basis. The Angel Tax is a tax levied under Section 56(2) of the Income Tax Act 1961, which is the difference in premium considered to be greater than the fair value of the shares. Tax officers still consider the appraisal that angel investors invest in to be greater than fair market value and then issue a supporting notice to charge taxes for that excess amount. This tax, as such, is known as angel tax. This section only applies to shares of unlisted companies that are not widely owned.


Income Tax Notice

Almost all startups receive funding in the first stage through angel investors during their first year of operation. For that year, its net operating results are usually operating losses, as the amount invested is spent on the technology or the compensation of the people working as such. Therefore, when you file income tax returns, these returns show a loss from business operations. At the same time, the infusion of capital appears first. Therefore, in the random check analysis, this premium led share capital is considered abnormal, and tax analysis notifications are sent to emerging companies to clarify the valuation basis with the valuation report. This section of 56(2) is sometimes used to harass startups, who are always greedy for money and funds.


The impact of the Angel tax on investments

These tax notifications will certainly affect the businesses created, including investments in these new businesses. The Government has already made paying taxes easier by creating protections, although it has not been able to alleviate the suffering of new businesses. As startups are assessed based on the commercial potential of their ideas, which can change over time, it is sometimes difficult to justify the share premium received. Since the percentage of successful startups is very low, it could be less than five in 100 startups, these warnings are usually painful, and angel investors are wary of promoting brilliant ideas and prefer to invest in phase—two when the initial funding is already available, and the project shows its shape. At the same time, good projects will continue to increase, and within two years, with this tax measure in place, the negative impact on new investments will disappear.


How should startups handle these tax notifications?

Startups should be aware of the assessment process acceptable to tax authorities. Now, a certified valuer, including a commercial banker, can only generate the value they need to authenticate based on their expertise. This certificate will help startups to satisfy supervisory authorities as to the authenticity of the transaction.


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