Start-up tax, a totally new concept in India, was first proposed by the former Finance Minister, Mr. Pranab Mukherjee, in his budget speech, 2012. It was triggered mainly to curb the mala fide practices (to cite example, 2G scam and money laundering) generally followed by the closely held companies, where the investors purchased the shares of a newly started business at a premium in excess of the fair market value of the shares to escape the income and/or service tax net falling on the start-up company.
Startup tax, amended for good
The Finance Minister’s speech on proposing to tax the angel investors investing their funds in the closely held companies (i.e. the companies in which the public is not substantially interested) has remained a topic of worry for a large chunk of these angel investors. This tax is now commonly termed as ‘Startup tax’. This tax was proposed to be implemented under the General Anti-Avoidance Rule (GAAR).
The mechanism of the start-up tax can be well broken down to a case study. Suppose an investor invests Rs. 1 crore in a start-up carrying 25% share in the company valuing the company at Rs. 4 crores. However, the hypothetical fair market valuation of the company by the assessing officer is done at Rs. 1 crore, then the taxable premium of the investor will be equal to the excess of the investment made over the investor’s stake as per the fair price valuation, i.e. Rs. 1 crore – Rs. 25 lakhs = Rs. 75 lakhs. The proposed startup tax @ 30% would amount to Rs. 22.5 lakhs to be borne by the start-up company.
Benefits and Further Proposals
However, the angel investors and the start-ups took a sigh of relief as on May 7 2012 the FM in his speech on the Finance Bill said “It has been proposed in the Finance Bill that any consideration received by a closely held company in excess of the fair market value of its shares would be taxable. Considering the concerns raised by ‘angel’ investors who invest in start-up companies, I propose to provide an enabling provision in the Income Tax Act for exemption to a notified class of investors”. This is sure to bring smile on the faces of the entrepreneurs. The investors said that it was a huge boost to see that the FM had understood the legitimate concerns of the startups and angel investors and had proposed an exemption to a notified category of investors.