NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Monday, March 19, 2012

Start-ups raising money from angel investors will have to pay income tax from April on the funds they receive after the national budget on Friday proposed to treat the capital received as income from other sources, if the consideration received for issue of shares exceeds the face value of such shares.

For instance, consider an angel investor who plans to invest Rs.10 lakh in a start-up that has Rs.100,000 as paid-up capital, or 10,000 shares at a face value of Rs.10. To give the investor a 20% stake, the start-up will have to issue 2,000 shares. However, since the investor plans to infuse Rs.10 lakh, he acquires the shares at Rs.500 apiece, much more than the face value.

In India, experts estimate that nearly 90% of start-ups fold up in the first two years of their inception for lack of funding support.

Angel investors include corporate chiefs, businessmen and wealthy individuals who invest their own capital—mostly between Rs.20 lakh and Rs.1 crore—in firms that are often nothing more than business ideas. In India, such investments are tiny—estimated at less than $300 million in three years—but still represent an important source of capital for start-ups. Angel investors typically invest in companies that deal with sectors that personally interest them, and are often the first investors in a company.

“This clause will completely kill all angel investment in the country and with that, spell the death knell of first-generation entrepreneurship that had begun to mushroom over the last few years,” said Indian Angel Network Services Pvt. Ltd co-founder Saurabh Srivastava, adding that various measures enunciated for small and medium-size enterprises (SMEs) will come to naught because of this one clause because angel investment precedes venture capital investment.

“Rather than giving the angel investor a tax break for making such risky investments for the common good (creation of wealth and employment), as is done by most countries in the world, we are in effect taxing them and, therefore, encouraging them to put their money in unproductive assets like farm houses and real estate,” said Srivastava.