The devil in the details

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Let’s examine and evaluate each of the changes in turn.

First, the exemption limit has been increased from Rs 10 crore to Rs 25 crore.

According to an iSpirt post, if one looks at the data from a startup survey in January 2019, “nearly 96% of startups that had received notices regarding angel tax, had raised below the permissible limit of Rs 10 crore”. Therefore, raising the exemption limit will only benefit a sliver of startups, if at all.

Involving an institutional investor

In any event, funding amounts beyond Rs 10 crore typically involve an institutional investor, which means that the angel tax section is not applicable in any case. And expecting listed companies to invest in startups simply because the angel tax clause has been waived for them is akin to hoping that people will buy a house simply because it isn’t haunted—removing a deterrent from the equation is a far cry from catalyzing the desired action.

Secondly, the eligibility tenure of a startup has been extended from seven to ten years.

It is not clear who actually asked for this change as it benefits no one. If a startup hasn’t figured out its business model in the first seven years of its existence, it is unlikely to do so in the next three. So the possibility of raising funds from angel investors in year eight onwards is a remote possibility.

If this is intended to be an extension of tax benefits, that whole aspect is firmly in the grey area with absolutely no clarity on how companies can avail such tax holidays in the first place. Also, from a broader perspective, most startups, especially those who have succeeded at scale, will not begrudge paying tax on their income. So the lure of these sops is limited at best.

The next issue relates to the restrictions around the use of funds. Companies are restricted from making capital contributions to any entity, which means that a startup cannot have subsidiaries.

The results of the process

This will make things even tougher for startups operating in regulated spaces such as fintech and e-commerce, where having a group of companies is not just desirable but necessary to comply with regulatory requirements around aspects such as ownership percentages and registered domicile.

It is also unclear whether the clause prohibiting buying “shares and securities” applies to debt mutual funds, where most startups tend to keep their unutilized capital.

Beyond these specifics, the biggest problem with the notification is that it seems to do absolutely nothing for the 150+ startups who have already been served notices.

There is no clarity on whether the proceedings against these companies have been halted. If anything, the clause mentioning that there will be “no case by case evaluation of exemption” actually seems to indicate the exact opposite of what was demanded—that there is no special relief for these startups in the offing any time soon.

The notification also studiously avoids addressing the matter of other clauses, such as Section 68, that have been invoked to initiate action against startups.

It is these grey areas—where aspects are either not clear or comprehensive—that inevitably leads to more complications for the targeted startups. The specter of a single tax section might have been lifted, but these aspects that are open for interpretation are more than enough ammunition for a tax official chasing a revenue target to beat you up with.

But the biggest danger of this notification has to do with the way that the government now defines and recognizes startups.

Pandora’s box

Prior to these changes, for a company to be registered as a startup with DPIIT, it had to demonstrate that it leveraged technology in some innovative way and a panel evaluated this claim. Now, there is no requirement—any company can submit a declaration that it qualifies to be a startup and there is no evaluation process as such.

There are two problems with this.

The fact that there is no merit-based qualifying criteria or an evaluation process now means that pretty much any company can now register itself as a startup. Not only will this crowd out genuine startups who deserve to be promoted and encouraged by the government, but it will also lead to the exact opposite outcome of what the angel tax clause originally intended.

This loophole will allow shadowy players to set up shell companies that will allow them to do the exact surreptitious activities that the law was intended to curb in the first place. The fact that the companies no longer have to justify share premiums will open up a host of avenues for miscreants to squirrel away money to avoid tax and scrutiny.