Is the angel tax cure worse than the disease?

Are you a founder or an investor in an Indian startup?

If so, have you heard of the “Department for Promotion of Industry and Internal Trade”?

If not, you better familiarise yourself with it.

Why so?

The dependency of the project

Quite simply, your continued existence as a startup is no longer dependent on how good your product is or how big your market is. Instead, it depends on whether the Department for Promotion of Industry and Internal Trade or DPIIT for short, deigns to allow it.

Known earlier as the DIPP (Department of Industrial Policy and Promotion), the DPIIT is a governmental body housed under the Ministry of Commerce and Industry with a mandate to “look into all matters related to promotion of internal trade, including retail trade, welfare of traders and their employees, facilitating ease of doing business and startups”.

If the word “startups” seems like an afterthought in this list, it is probably not a coincidence. The fact of the matter is that despite all the recent lip service that government officials deliver about startups, history will tell you that the success of Indian startups has little to do with the government.

If anything, one could actually say that Indian startups succeeded despite the government rather than because of it. Take Flipkart for instance—the company had to shift domicile to Singapore at an enormous cost to comply with the government’s FDI regulations. Or take Ola’s battles with governmental bodies over ride-sharing laws.

Not interfering with the startups

India’s IT industry created global powerhouses like Infosys, TCS, and Wipro only because Indian governments did not interfere with them when they were startups.

While the relationship between Indian startups and the government has historically been largely passive, it was nevertheless one about which neither party had any problems. The government was okay with letting startups do their own thing as long as there were no bad optics that it had to overcome for sacred cows such as “protecting the small trader”. For their part, Indian startups were okay working around these regulations as and when they encountered them, accepting them as part and parcel of the cost of doing business in India.

But all that changed in 2012, when a seemingly obscure tax code called Section 56(2)(viib) was introduced. The intent of this provision was to curb tax fraud involving financial transactions wherein shares of a company were purchased at premiums that exceeded their deemed fair market value and the corpus subsequently utilized for surreptitious purposes and tax avoidance.

This clause subsequently gained infamy as the “angel tax” when startups were targeted by the tax department. Startups were asked to treat share premiums deemed in excess of their fair market value as “income from other sources” and taxable at 30% on par with corporate taxes. Ken has covered angel tax fairly extensively in the past, explaining the contours and imperatives.

Specter of anger

But in the past few weeks, the specter of angel tax seems to have reached a crescendo, with startups complaining of draconian steps invoked by tax authorities. By some estimates, over 150 startups have been issued notices invoking this clause, and in some cases, bank accounts of targeted startups have been frozen, and bank balances emptied out without their knowledge.

Predictably, this announcement was met with exultation from sections of the startup ecosystem, especially the lobbies who had engaged with the government. They called these changes “historic” and prophesied that this “will transform India’s economy, generate millions of jobs, and solve India’s pressing challenges in healthcare, education, agricultural productivity, clean energy, and much more”. Even if you discount parts of this as hyperbole by cronies who waste no opportunity to suck up to the powers-that-be, on the surface of it, it does seem that these changes could fix the vexatious aspects of the angel tax.

But if you scratch the surface, it is apparent that this is at best, window dressing.