Applicants can seek registration as an AIF in one of the following categories, and in sub-categories thereof, as may be applicable:
Angel investors come in after the original funding is in place but typically before a company requires a more sizable investment from a venture capital company. Their investment is needed to grow a company at a critical (and usually early) stage of development; after the initial funding threatens to run out and before venture capital groups show interest in partnering with a promising business.
Angel investors connect with young, developing companies through word of mouth, through business and industry seminars or conventions, through referrals from professional investment organizations, from online business forums or via local events like chamber of commerce meetings.
If there’s mutual interest, the angel investor will conduct due diligence on the young company by talking to the founders, reviewing business investment documents and gauging the industry the company is targeting.
Once a verbal agreement between an angel is in place, a term sheet or contract is drawn up, with agreements on the investment terms, payouts or equity percentages, investor rights and protections, governance and control parameters and an eventual exit strategy for the angel investor.
Once the contract is finalized an actual legal agreement is created and signed, the deal is officially closed and the investment funds are released for the company’s use. Some angel investors group together as a syndicate and can provide funding up to $1 million for select companies.
Angel investors don’t usually acquire more than a 25% stake in a company. Veteran angel funders know that the company founders need to hold the highest stake in their own companies as they then also have the highest incentive to make their companies successful.
There are several reasons why emerging startup companies might partner with an angel investor.
Angel Investor Advantages
Reasons for Ineffective growth rate of start-ups despite of exemptions
The number of start-ups eligible for the exemption from angel tax saw an increase from 1867 as of December 31, 2019, to 3,612 start-ups as of February 3, 2021. Despite the 93.4 % jump, this exemption which was intended as a breather to start-ups, turned out to be a dampener due to the following reasons:-
Start-ups invest the surplus funds raised in debt mutual funds to multiply their funds. A blanket restriction on investment in shares and securities hampers the investment and growth opportunities of start-ups.
Start-ups give salary advances or loans to employees and these start-ups are now not eligible for the exemption from angel tax. This embargo on loans and advances, without any threshold limit, is far too constraining.
Start-ups are barred from making a capital contribution to any other entity. This again creates obstacles for companies, looking to expand their operations through mergers and acquisitions or setting up subsidiaries. Further, those start-ups that operate in sectors that require liaisons (fintech, e-commerce) with other firms to sustain long-term growth are also burdened. It is now the new normal among start-ups to merge and/or acquire, as is evident from the cases of Zomato and Uber Eats & Byju’s and White Hat Jr, amongst other acquisitions.
As per a Nasscom-Zinnov report, Indian start-ups take an average of 6-8 years, to reach a $1 billion valuation. Start-ups like Ola, Udaan, and Glance have attained unicorn status in about 2.4 years. Given the need to fast-pace the growth of Indian start-ups, a 7-year restriction on down-stream investments seems unaccommodating.
Most importantly, the restrictions on the deployment of funds are not limited only to the money raised from the angel tax investors but a blanket restriction on all these activities for 7 years. In other words, start-ups are prohibited from such investments/ deployment even out of the capital raised subsequently from VCCs, VCFs or any other nonresidents for 7 years, which are excluded from the threshold of 25 crore mentioned supra.
Article 68 adds a huge tax liability for startups if they cannot disclose the source of funding.The unexplained fund receipts push young entities into various financial troubles. Young entrepreneurs go through many pains to get funding, and the least the government can do is not add more hindrances to their growth by adding more taxes on their funds.
The failure to satisfy any of the conditions for 7 years would result in the excess consideration (share premium less FMV) being treated as income of start-ups. The consequential penalty of a whopping 200 % penalty on such an amount under Section 270A of the Act seems draconian for exploring further developmental opportunities and effectively, a penalty on growth.
Previously, angel tax exemption was limited to enterprises with a revenue of up to 25 crores; however, under new guidelines, the exemption limit has been increased to companies with a turnover of less than 100 crores and that are less than ten years old.
Furthermore, investments made by listed firms with a net worth of at least $100 million or a total turnover of at least $250 million, as well as investments made by non-resident Indians, will be tax-free.
A qualified start-up is one that is registered with the government, has been in operation for less than 10 years, and has generated less than $100 million in revenue during that time.
In addition, the Finance Minister stated that an e-verification mechanism will be implemented to address the issue of verifying the identity of the investor and the source of his cash. As a result, monies raised by startups will not be scrutinized by the Income Tax department.
Startups would not be required to present the fair market value of their shares granted to certain investors, such as Category-I Alternative Investment Funds (AIF).
The Startup India Campaign was launched In 2016 in order to increase entrepreneurship and build a strong and inclusive ecosystem for innovation in India Through this campaign, various aspects of running a start-up, such as bank financing, tax exemptions, simplifying the process of registering the business and other benefits were targeted, in order to make running a business more appealing to India’s youth.
Eligibility Criteria for Startup Recognition:
The Start-up should be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership.
An entity shall be considered as a start-up up to 10 years from the date of its incorporation.
Turnover should be less than 100 Crores in any of the previous financial years.
The company remains a start-up if the turnover per year does not cross the 100 crore marks in any of the 10 years. Once the company crosses the mark, it no longer remains eligible to be called a start-up. The mark of 100 crore too has been improved by the Indian government in the recent past from 25 crore.
The firm should have approval from the Department of Industrial Policy and Promotion (DIPP).
The Start-up should be working towards innovation/ improvement of existing products, services and processes and should have the potential to generate employment/ create wealth.
An entity formed by splitting up or reconstruction of an existing business shall not be considered a “Start-up.
Benefits Available to an Eligible Start-Up
Following benefits shall be available to an eligible start-up or its shareholders:
Unlisted start-ups can raise money from resident investors by selling their closed shares. Angel tax is levied on start-ups when they receive investments in excess of their ‘fair market value’. The perceived profit is considered as income from other sources—it’s taxed at 30% and termed as angel tax. Note that angel tax isn’t applicable in case of investments made by venture capital firms or foreign investors. It’s limited to investments made only by Indian investors.
Angel tax is levied on the capital raised via the issue of shares by unlisted companies from an Indian investor if the share price of issued shares is in excess of the fair market value of the company. The excess realization is considered as income and therefore, taxed accordingly.
It applies to resident Indian investors only.
It’s difficult to determine the fair market value of a start-up. Section 56 of the Income Tax Act 1961 explains how to calculate this value. It may be determined by considering intangible assets like good will, know-how, patents, licenses, copyrights, and movable assets.
However, this definition brews the discontent among start-ups and the income tax department. Income tax is strictly run by the rule book in India. So, it’s not possible to correctly estimate the projected growth of start-ups while calculating the fair value.
Angel investors are high net worth individuals who invest their personal income in business start-ups or small and medium scale companies.Angel investors are wealthy individuals who can supply their own money for a start-up in return for ownership equity. Unlike investment firms, which invest other people’s money in start-ups, angel investors use their own money. These investors are often impressed by the offerings from start-ups and do not look for a profit margin. They might just invest out of goodwill as well.
Other terms used for angel investors are informal investors, angel funders, private investors, seed investors, or business angels. Very few wealthy Indians actually take up this role due to complex taxation policies. A more open system will see more Indians investing in start-up ventures in India.
Angel investors finance small startups. They provide funds at a stage where such startups find it difficult to obtain funds from traditional sources of finance such as banks, financial institutions, etc. In this way, they encourage entrepreneurship in the country. Further, such investors provide mentoring to entrepreneurs as well as access to their own business networks. Thus, they bring both experience and capital to new ventures.
In India, unlike in the US, the angel investor does not get any tax rebate for the investment to small businesses. So, people can invest their black money in start-ups and make it legal. Angel tax was introduced to prevent money laundering that might happen in the name of investment.However, computing the fair market value for a start-up has remained a point of disagreement. Measuring intangible assets is difficult and hence one could get only a subjective rating. But this rating could be considered differently by different people. If the value is placed high, it’ll benefit start-ups as they would have to give up less equity
Suppose a closely held company issues equity shares and an investor buys those at a price above their fair value. The excess amount received by the company will be treated as income from other sources. The company should pay 30% of the excess amount plus the applicable cess value as tax.If that closely held company is a start-up, the tax paid on such excess receipts is termed angel tax. The person purchasing its shares is called the angel investor.
However, this rule will not be affective in the following cases:
The government has recently relaxed the procedure to apply for exemption of angel tax. Any eligible start-up can contact the Department of Industrial Policy & Promotion (DIPP) with supporting documents for angel tax exemption. Applications of DIPP-recognized start-ups will be forwarded to the Central Board of Direct Taxes (CBDT) along with these documents.The CBDT will accept or decline the request within 45 days from the day of receipt of the application.
In India, start-ups are majorly funded by venture capital firms or foreign investors. Angel investors are very few and limited. Only certified start-up is exempted from angel tax. Currently, only a handful of start-ups are certified. If the angel tax rules are relaxed, more investors would be interested in investing in start-ups.
A large number of start-ups have received notices from the income tax department to pay up to 30% of their funding as angel tax. Many of the angels are receiving notices to disclose their source of income, bank statements, and other documents. This has caused a major disturbance among start-up founders and angel investors.
The government has announced that no coercive action will be taken to collect this tax. It has set up a committee to look into this matter. Already, some of the conditions have been relaxed for start-ups. At present, start-ups incorporated before April 2016 are eligible for angel tax exemption if their aggregate amount of paid up share capital and share premium does not exceed 10 crore.
The government is still working on the issues of start-ups and demands by the founders of such start-ups. The investment limit might be hiked to 25 crores or 45 crores from the current 10 crore ceiling. These exemptions might be applicable after the start-ups submit an undertaking that the money received will not by misused. The government will also most likely certify all the ventures running for 10 years as start-ups, extending from the previous limit of seven years.
Startups are the young ventures that are just beginning to develop. Startups are usually small and initially financed and operated by a handful of founders. These organizations are generally driven by the latest technology and innovation and have rapid growth prospects. Today India is the 3rd largest hub for entrepreneurs from around the world harboring approx. 26,000 start-ups right now. Government has encouraged startups by implementing programs like make in India and Startup India but the introduction of Angel tax has threatened to undo all hard work by Government.
Angel tax was introduced in 2012 union budget by then finance minister Mr. Pranab Mukherjee. Angel tax is a Term used for Income tax levied on amount recd. Exceeding the fair market value of the share of a company Three conditions are to be satisfied to invoke the provisions of angel tax
Fair market value shall be calculated as per the provisions as prescribed under the rule 11UA (2) as on the date of issue of such share. There are two methods are prescribed under the rule so as to determine the FMV of the share.
Typically, angel investors are eligible for angel tax exemption under Section 56(2) (viib) of the Income Tax Act. It means that they will have to pay taxes only on that amount by which the sum total received from the issues of the startup's shares overtakes the fair market value.
As per the income tax notification, angel investors with the minimum net worth of 2 crore or the average returned the income of more than 25 lakhs in the previous 3 financial years will be eligible for 100 % tax exemption on the investments that are made in the start-ups above the fair market value.