NEW DELHI : Taxation of share premium in unlisted businesses, an anti-evasion provision introduced in the tax law more than a decade ago to tackle corruption, has over the years become a key concern for startups, with the industry waiting to see how its expanded scope will be implemented on the ground.
The finance ministry is set to come out with the final version of the five extra valuation methods for foreign investors in about a fortnight to ensure the worth of unlisted companies is accurately assessed for tax purposes after public consultation of the draft rules in May.
An investor in several companies said founders of startups negotiate with potential investors to raise capital based on the future worth of the enterprise, not the present one so that his equity dilution in the company is less. For the same amount of capital raised, founders may have to let go of a larger pie in the company when valuation is lower. “The angel tax provision definitely is a dampener for startups,” the person said on the condition of anonymity.
However, government officials do not feel the same. “Potential investors are not naive enough to put money on the table just because startup founders promise the moon. If they find worth in the enterprise, it will not be that hard to explain the value to the tax department as well,” said a tax official, who spoke on condition of anonymity.
In an interview published by Mint on 16 July, revenue secretary Sanjay Malhotra said the government’s effort is to allow genuine investments and, at the same time, to ensure there is no money laundering, round-tripping of funds, etc. Besides, the methods given for fair valuation take into account the growth prospects of companies, Malhotra then explained, calling the legal regime a balanced one. Also, recognized startups and investments from certain entities have already been exempt from angel tax provisions.
In the 2012-13 Union budget, the then finance minister Pranab Mukherjee introduced the provision to treat share premium received above the fair market value of an unlisted company from a resident investor as taxable income. That proposal came amid reports of some companies backed by regional politicians receiving allegedly inflated investments in return for political patronage. The startup ecosystem that took off in a big way in the last 10 years, however, claims the angel tax provision comes as a dampener in their quest to raise funds. The Finance Act this year extended this treatment of share premium to investments from non-residents, too.
The five new valuation methods prescribed for non-residents are in addition to the discounted cash flow method, which is already available and will be available for use, explained Amit Maheshwari, tax partner, AKM Global, a tax and consulting firm. Hence, the new rules only provide flexibility to use additional methods where the existing methods—DCF and net asset value (NAV)—may not be appropriate, Maheshwari said.
Despite the flexibility allowed by the government, valuation remains a subjective exercise.
“Valuation by nature is a subjective exercise, and the valuers always look to use the most suitable methodology to value any business. Hence, in a way, the new regime intends to rationalize the angel tax provisions and is a welcome step given that regardless of how many methods are prescribed, the fact remains that valuation is subjective and might lead to litigation,” Maheshwari said.
A second government official, who also spoke on condition of anonymity, said that the industry keeps on asking for privileges and special treatment in the name of being a startup. “Who decides whether one is a startup? If an entity is set up by IIT graduates and has opened an office in say, Gurugram, everyone quickly take it as a ‘startup’, but not if a common man has opened a shop in say, Karol Bagh,” the official said.
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Updated: 06 Sep 2023, 11:48 PM IST