The Indian government’s new provision on bringing parity between domestic and foreign investors in start-ups has remained unchanged and will come into effect from 1 April 2024. This new amendment means that there is no exemption for overseas investors, and they need to pay a tax on deals. If startups raise funding from non-resident investors, it will be considered income and taxable.
Startup Ecosystem and Angel Tax
Thinking for any startups is just a roller coaster ride in itself, thinking of financiers and making different pitches to impress the angel financier or any big business daddy is one of the common things when you don’t have enough money for your business to get started. The angel tax comes with financial benefits from angel financiers or foreign investors.
However, the government of India announced no relief for the angel tax. The Finance Bill, 2023 with 45 amendments on Friday, has been a subject of concern for many venture capitalists. They have been saying that this will negatively impact funding for start-ups. With the new amendment, if start-ups raise funding from non-resident investors, it will be considered as income and taxable. This amendment in the Finance Bill, 2023, means there is no exemption for overseas investors, and they need to pay a tax on deals.
The concerns of the start-up community
The move has been met with widespread criticism from the start-up community. Many believe that it could stifle the growth of the sector and discourage foreign investment. Some start-up founders have already started looking for alternative locations to incorporate their businesses, where tax laws are more favorable.
Vinod Shankar, Co-founder & Partner at Java Capital, said, “The startup ecosystem is already facing a funding winter for quite some time now. I believe that now Indian startups will find it more difficult to receive funding from foreign investors. It might incentivize startups to locate overseas to avoid paying the tax.”
The government’s move could have far-reaching implications for India’s start-up ecosystem. According to a report by Venture Intelligence, a firm that tracks start-up investments, Indian start-ups raised $1.5 billion from foreign investors in the first quarter of 2022 alone. This figure could fall dramatically if foreign investors are required to pay the angel tax.
Parity between domestic and foreign investors
The government’s decision to bring parity between domestic and foreign investors is aimed at addressing the issue of “round-tripping.” Round-tripping is a process in which an Indian investor invests money in a foreign company, which then invests the same money back into an Indian company, thereby avoiding taxes.
By requiring foreign investors to pay the angel tax, the government hopes to prevent round-tripping and ensure that Indian start-ups receive genuine foreign investment. The government also hopes that the move will encourage Indian investors to invest in domestic start-ups rather than routing their money through foreign companies.
However, the start-up community argues that the move is unnecessary and could do more harm than good. They point out that foreign investment is crucial to the growth of the start-up ecosystem and that the government should be looking to encourage, rather than discourage, foreign investment.
The impact on venture capital
The government’s decision to tax foreign investors could also have a negative impact on venture capital (VC) investment in India. Venture capital funds are a key source of funding for start-ups and typically invest in early-stage companies with the potential for high growth.
According to data from Venture Intelligence, VC investment in Indian start-ups hit a record high of $17.3 billion in 2021, up from $14.2 billion in 2020. However, the new angel tax could lead to a drop in VC investment in Indian start-ups, as foreign investors may be deterred by the additional tax burden.
The Indian start-up ecosystem has grown rapidly in recent years, driven by a wave of entrepreneurial activity and a supportive government. However, the new angel tax has raised concerns that the growth of the sector could be slowed or even reversed.
The government’s decision to require foreign investors to pay the angel tax has sparked controversy in India’s start-up community. While the government argues that the move is necessary to prevent round-tripping and encourage domestic investment, many in the start-up community believe that it will stifle the growth of the sector and discourage foreign investment.
The true impact of the angel tax remains to be seen. However, it is clear that the move has raised concerns about the future of India’s start-up ecosystem and the government’s commitment to supporting innovation and entrepreneurship.