Higher exemption ceiling for Angels

'Angel tax' has set the startup world aflutter yet again, this time over its extension to investments by foreigners. The government is trying to reduce frothy startup valuations that have spectacularly drained investor wealth after listing on Indian bourses. Angel tax, introduced to check unaccounted money circulating as share premium, was not imposed on foreign investments, which face gatekeeping checks through exchange control. The budget this year has closed this tax arbitrage, and exemptions provided are designed to corral the flow of capital to registered startups through alternative investment funds (AIF). The tighter scrutiny is warranted by the share of foreign investment in India's startup ecosystem.

The tax treatment of funds raised from any source by startups makes issue of shares to investors at fair market value the most viable option. This could have an effect on investment plans, and may sway the argument for incorporating abroad. India's current crop of unicorns has an inordinate share of firms operating from more business-friendly jurisdictions. The investment winter is making startup valuations more realistic. Regulatory requirements that pin them to fair market value through the hyper-growth stage can be unnerving for entrepreneurs and investors alike. It does not serve the ecosystem if trees grow roots on foreign soil.

Startups have valid reason to seek a higher ceiling of exemption from angel tax. They have lost access to richer valuations as input costs have climbed. Startups also need some flexibility in deploying surplus funds. The pool of foreign investors exempt from angel tax can be widened to, say, sovereign wealth funds (SWF) and pension funds that face extra compliance requirements. Tolerance may need to be built into startup valuations and methodologies. The government is seeking industry feedback on angel tax before finalising valuation and exemption rules. Hopefully, these will restore confidence among startups about their ability to secure funding.