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The Department for Promotion of Industry and Internal Trade (DPIIT) is working closely with the Finance Ministry to address the concerns of startups regarding the contentious angel tax and fair market valuation, according to a top government official.

The Union budget proposal to subject foreign investors to angel tax has raised apprehensions among startups about securing funding. Angel tax is levied on the capital raised by an unlisted company by selling shares to investors above the fair market value.

Indian startups, already facing a funding freeze, are worried that the angel tax may further deter foreign investors, as they often sell shares at a high premium based on future growth prospects.

The provision, scheduled to take effect on April 1, 2024, remains unchanged in the Finance Bill for the current fiscal year. The startup sector is already grappling with decreased funding, as foreign private equity and venture capital investments in Indian startups dropped to $54 billion in 2022 from $77 billion the prior year.

Furthermore, startup deal volume in India reached a nearly nine-year low in February, reflecting weak sentiment within the ecosystem.

A government official, requesting anonymity, stated, “There are concerns regarding angel tax coming from startups, and DPIIT is taking it up with the Department of Economic Affairs and Department of Revenue.

Calculation of their fair market value (FMV) is different, which is taken internationally and by the income tax department. DPIIT is just trying to get them on the conversation table, tell them that there is a discrepancy and find some solution.”

The government is contemplating exempting foreign funds from angel tax compliance, and rules on angel tax are expected to be issued this month, outlining exemptions for select foreign entities that are bona fide investors.

The first set of foreign funds likely to be exempted includes sovereign wealth funds such as Abu Dhabi Investment Authority, GIC, and Qatar Investment Authority.

This is due to concerns that the potential impact of Section 56(2)(vii)(b) tax could negatively affect foreign investments, which may undermine the government’s infrastructure investment push.

The government has previously argued that the angel tax, or Section 56(2)(vii)(b), targets ‘hawala’ transactions rather than startups, and that ending ‘preferential treatment’ for foreign investors would level the playing field since Indian residents are already subject to this tax.

However, the industry argues that, in practice, the law affects a significant number of startups and investors. Queries sent to the spokespeople for the Ministries of Commerce and Finance remained unanswered till press time.

Anurag Jain, Secretary of DPIIT, said that angel tax would not apply to startups registered with the DPIIT, which currently number around 95,000.

Tax experts said that angel tax is applied when the share price assigned to investors exceeds the FMV of the share.

The difference is then subject to Section 56(2)(vii)(b), which experts say could lead more startups to consider relocating overseas, as foreign investors may avoid additional tax liabilities stemming from their investment in the startup.

In conclusion, the DPIIT and Finance Ministry are actively working towards resolving the concerns of startups regarding angel tax and fair market valuation.

The government is considering exemptions for select foreign entities to avoid potential negative impacts on foreign investments.

However, startups in India continue to face funding challenges, and the industry is hopeful for a favorable resolution to support the growth and development of the startup ecosystem in the country.

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