Investments in start-ups: House panel proposes removal of LTCG tax for two years

The angel tax is typically an impost on the extra capital raised by an unlisted firm through the issue of shares over and above their fair market value.The angel tax is typically an impost on the extra capital raised by an unlisted firm through the issue of shares over and above their fair market value.

The Parliamentary standing committee on finance has suggested that the long-term capital gains (LTCG) tax be abolished for at least two years on investments in start-ups made by collective investment vehicles (CIVs) such as angel funds, alternative investment funds (AIFs) and certain limited liability partnerships (LLPs).

“After this two-year period, the Securities Transaction Tax (STT) may be applied to CIVs so that revenue neutrality is maintained,” said the report of the panel, headed by former minister of state for finance Jayant Sinha. The report titled, Financing the Start-up Ecosystem, was tabled in Parliament at a time when the Covid-19 pandemic has threatened the survival of thousands of start-ups that are gasping for liquidity. Tighter scrutiny of Chinese investments has added to the difficulty in getting funds.

Venture capital investments in start-ups crashed between April and July in the wake of the pandemic. Domestic start-ups witnessed 40 Series A deals worth $156 million during the period, sharply lower than the 66 worth $421 million between December and March, according to Venture Intelligence data.

Similarly, 33 Series B deals worth $320 million were concluded in the April-July period, against 42 such deals worth $485 million in December to March. The number of series C investments remained almost flat at 22, but deal values dipped from $362 million to $338 million in the April to July period.

Replacing the LTCG with the STT will make the taxation system fairer, less cumbersome, and transparent, the panel said. It will also ensure that investments in unlisted securities are on a par with investments in listed securities.

The panel endorsed the industry’s view that capital gains on AIF returns should be calculated after setting off management fees. Additionally, asset management services provided to foreign investors should be treated as an export service and should not be subjected to the goods and services tax (GST).

“This would also encourage the growth of the asset management industry in the country instead of fostering the current scenario, where funds are being pooled offshore and not within the country,” the report said.

The panel also suggested that tax exemption for income on investment made in only infrastructure projects should be extended to all sectors. The Finance Act 2020 has given this exemption for investment made before March 31, 2024.

“Given that the Indian economy is reeling under the Covid-19 crisis and various sectors need capital to recover, the committee recommended that the exemption for income on investments made before March 31, 2024, subject to the investment being held for a period of at least 36 months as incentivised in the Finance Act, 2020, should be provided to long-term and patient capital invested across all sectors,” it said.

To arrive at the correct valuation of start-ups, which has caused frequent frictions between promoters and the income tax department, the panel has suggested that an expert committee be set up to establish a framework for this. The I-T department had sought to tax share sale of these companies based on conventional methods of calculating fair market value while the promoters have argued that these businesses are valued more on their future potential than current cash flow considerations.

Following several complaints, the government, in a breather to start-ups, had in February 2019 raised the cap of funding by unlisted firms or individuals in a start-up that would be exempted from the so-called angel tax to Rs 25 crore from Rs 10 crore and also relaxed a clutch of rules to ease investment flow into such entities. Investments by listed companies having a net worth above Rs 100 crore or annual turnover of Rs 250 crore will be exempted from any such limit, which will enable them to invest more without fears of the angel tax.

The angel tax is typically an impost on the extra capital raised by an unlisted firm through the issue of shares over and above their fair market value. According to Section 56(2)(viib) of the I-T Act, the excess capital so raised is treated as income and taxed accordingly. While the section was aimed at curbing money laundering, it had troubled start-ups and their investors.

“Under the current environment, given that the businesses are stressed for liquidity and valuations of businesses have softened, there is a need to adopt a more pragmatic approach on applying fair market value principles in transactions between independent parties,” the report said.

It added that the pricing guidelines prescribed under the various laws and regulations by Sebi, Income Tax Act, Companies Act, Foreign Exchange Management Act (Fema) should be made more consistent to provide a certain, coherent and simple framework for facilitating large-scale investments in India.

It’s been a dull April-June quarter for India’s internet consumer companies with just $480 million of capital coming in; that’s a fall of 60% over the $1.27 billion seen in the June, 2019 quarter. Data sourced from researcher Tracxn showed the amount is also considerably lower than the over $2 billion that companies raised in the March quarter.

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