Startups, investors buoyed by twin tax wins in “dream budget”

The measures, announced in the Union budget for 2024-25 on Tuesday, are expected to boost domestic capital investment into the Indian startup ecosystem, said investors.

Dismantling the entire angel tax provision is a bold move, said Gopal Srinivasan, founder and managing partner, TVS Capital. Tuesday is “a red letter day” also because of the new tax slab for long-term capital gains that brings parity between public and private investors, he said.

Both these changes were big asks from the investor ecosystem, and seeing them come true in the same budget makes it a dream, investors said.

The erstwhile angel tax under section 56(2)(viib) of the Income Tax Act applied to unlisted companies on issuing securities to investors at a premium to their fair market value. The difference was considered as “income” for the company and subject to tax.

Angel tax was introduced in 2012 to fight money laundering after the government found such investments, typically by wealthy individual investors, being used in certain instances to whitewash black money. However, this disproportionality impacted startups raising capital as investors usually invest at higher than the fair market value because of growth potential.

More often than not, startups or high-growth companies issued securities to incoming investors at a high premium to the fair value price as the assumption is that these companies will rapidly grow into their value.

“A tax on capital is antithetical to capital formation and this has long been used to harrass startups and investors,” said Siddarth Pai, co-founder of venture capital firm 3one4 Capital.

“Given the mandatory dematting of securities, Section 68 (of the Income Tax Act requiring the) disclosure of unlisted investments in tax returns has plugged the transparency gap for which angel tax was created, he said. “The removal of angel tax sans conditions must be celebrated as a major win.”

Finance minister Nirmala Sitharaman’s decision to abolish the angel tax, however, comes with a rider: it won’t be applied retrospectively. The abolition of angel tax comes into effect from 1 April, 2024.

Previous tax demands will continue, revenue secretary Sanjay Malhotra told Mint after the Budget was presented.

Parity at last

For long, private Indian investors have been paying a 20% tax on long-term capital gains in unlisted securities, which made Indian rupee-denominated venture capital and private equity funds tax-inefficient.

For the same securities, foreign investors paid 10% tax on long-term gains. Public market investors were also paying a 10% tax. Now, all asset classes will be taxed at 12.5% for long-term captial gains.

“Aligning the tax rates will result in more funding into Indian startups,” Pai said.

However, crucially, investors won’t be motivated by tax for their asset purchases, said Subramaniam Krishnan, partner, EY.

“Ultimately, they will look at the asset class based on their risk-return profile and make their investment decisions. However, foreign investors will pay marginally more tax on long-term capital gains (albeit on foreign currency gains where applicable). There is now almost total parity between residents and non-residents on long-term capital gains tax rates,” Krishnan added.

This move to even-out the disparity in long-term capital gains tax will inevitably boost the PE-VC industry, which currently stands at ₹2.5 trillion, only a “tenth of the Indian equity mutual fund pool,” said TVS Capital’s Srinivasan.

Space startups and other budgetary boosts

The budget also introduced the concept of variable capital company (VCCs) at the Indian Financial System Code IFSC-Gift City, which could promote the ease of doing business.

VCCs are accepted globally as a vehicle for investment funds, and offer a lower cost set-up and allow fund managers to introduce multiple sub-funds, like a mutual fund.

“Trusts were not conceived for the complex operations of VC/PE funds and the VCC structure will make GIFT IFSC even more attractive,” Pai said.

In another move, the budget also proposed reducing the timeline for the initiation of re-assessments by the tax department from 10 years to five years. This is crucial not just for individuals but also for companies closing large mergers and acquisitions.

Generally, sellers need to offer indemnities in case a buyer is charged with additional taxes long after a deal is closed. This move reduces the indemnty period.

In another measure, the budget’s proposal to launch a ₹1,000 crore-fund for the space economy is expected to be a boost for space startups. The push to develop a skilled workforce would also help startups scale up, experts said.