The abolition of the so-called ‘Angel Tax’, a thorn in the side for startups and private investors for over a decade, has been cause for much celebration within the ecosystem since the announcement last week as part of Union Budget 2024. The move, coming as it does at the tail-end of a long-drawn and painful funding winter in India’s startup arena, will boost entrepreneurial spirit and innovation.

Apart from the ‘Angel Tax’, this budget also touched upon buybacks, long-term and short term capital gains tax and provided a boost to the nascent spacetech sector.

Let’s unpack the key takeaways as relevant to the startup and venture capital ecosystem.

1. Where angels no longer fear to tread

Startups have become an important part of the government narrative over the past decade but the shadow of the ‘Angel Tax’ has always been a bit of a dampener for entrepreneurs and investors alike. Last Tuesday, in a big boost to the startup ecosystem, Finance Minister Nirmala Sitharaman finally set matters right. Effective April 1, 2024, ‘Angel Tax’ will no longer be applicable for all classes of investors.

As a recap, ‘Angel Tax’ is a tax provision under Section 56(2)(viib) of the Income Tax Act, 1961, which treated the investment received by startups from external investors as “income from other source” and taxed it at a rate of 30% if the share price of issued shares was seen to be in excess of the fair market value of the investee company.

While the ‘Angel Tax’ by itself has been cause for much heartburn, numerous amendments and clarifications over the years had made compliance even more complex.

Read:  Angel Tax Rules: Some Clarity But Not Complete Clarity – our earlier examination of the issue and its implications.

The abolition of the ‘Angel Tax’ reduces unwarranted tax litigation (and tax cost for the portfolio) that stakeholders have wrestled with for 12 long years. We could have been spared all that heartburn! 

The move retains and brings back flexibility to investment structuring based on arm’s length commercial principles (incorporating a price differential) and fluctuating valuations, without worrying about ‘Angel Tax’ provisions. Past litigation in this matter may continue, with no specific mention of the fate of past tax litigation in the Budget. The hope is that the Income Tax department will issue suitable guidelines and directions.

2. Long-term capital gains tax dampener

The Budget has established parity between resident and non-resident investors on capital gains – another long-standing demand from the PE/VC industry – but it comes at a cost. 

The long-term capital gains on all financial and non-financial assets will attract a tax rate of 12.5% against 10% earlier. The indexation benefit on cost of acquisition and cost of improvement shall no longer be available for long-term capital assets transferred on or after 23rd July, 2024. The provision adversely affects non-resident investors who were earlier taxed at 10% plus applicable surcharge and cess.

Additionally, the limit of exemption for capital gains will be set at Rs 1.25 lakh per year. Short term gains on certain financial assets shall henceforth attract a tax rate of 20%, up from 15% earlier. 

While the parity was expected, an increase in the long term capital gains tax rate was unexpected and is a dampener!

In summary: 

Note: Unlisted bonds and debentures, debt mutual funds and market linked debentures, irrespective of holding period, however, will attract tax on capital gains at applicable rates.

3. Capital boost for spacetech startups

Image credit: ISRO

When India successfully landed its Chandrayaan-3 spacecraft on the moon in August last year, it became the fourth country in the world to achieve the milestone. That scientists at the Indian Space Research Organisation (ISRO) were able to complete the mission within a budget of $75 million, a fraction of the cost of similar endeavours in the United States and Russia, delivering a significant leg-up for a growing contingent of homegrown spacetech startups that have been evolving cost-efficient models and solutions, and have been lobbying for a while for the government to allow for foreign investments into the fledgling sector.

Union Budget 2024 didn’t go as far as to enable foreign capital flows into private spacetech companies but it did make a move towards kickstarting capital inflow for the sector. With a stated view to expanding the space economy 5X over the next 10 years, the Budget outlined a provision for a Rs 1,000 crore venture capital fund to foster entrepreneurship and innovation in the field of space mobility and research.

Read more about Lightbox’s earlier analysis India’s potential in spacetech – India’s Space Story: One giant leap for mankind

4. Safe harbour rules for transfer pricing

It is proposed to streamline the current transfer pricing assessment procedures and expand the scope and extent of safe harbour rules to make it more attractive. “Safe Harbour Rules” are a provision in the tax laws stating that transactions falling within a certain pricing range will be accepted by the tax authorities without further investigation. 

The current rules in this regard have not been very effective and therefore have not been well adopted. This is a good step towards ease of doing business and minimising transfer pricing related litigation.  

5. FDI and ODI rules

As a positive, the rules and regulations for Foreign Direct Investment and Overseas Investments will be simplified to facilitate foreign direct investments. It is proposed to simplify the process, procedures and speed of approval. Some investment categories could be moved to the automatic approval route instead of the government approval route. It is also proposed that the government will look to promote opportunities for using the Indian Rupee as a currency for overseas investments.  The details are awaited.

6. Share buyback provision complicates M&A

Effective 1st October 2024, it is proposed that income from the buy-back of shares by companies will be chargeable in the hands of the recipient investor as dividend, instead of the current regime of additional income tax in the hands of the company. Further, the cost of such shares shall be treated as a capital loss to the investor. This makes M&A and structuring more complicated and unattractive. It has possibly been done to ensure that any form of cash return to promoters/shareholders whether as dividend or buyback, are taxed in the hands of promoters/shareholders rather than higher tax outgo on dividends 

7. Gifts can now be made only by an Individual or HUF

Effective FY 2024-2025, the transfer of a capital asset, under a gift or will, or an irrevocable trust, by an entity other than an individual or a Hindu undivided family (HUF) only, shall be regarded as transfer for the purpose of calculation of capital gain. This makes any gift related structuring unfeasible unless done out of natural love and affection, the original principle on which gifts should in fact be made.

8. Integrated Technology Platform under IBC

An Integrated Technology Platform is proposed to be set up for improving the outcomes under the Insolvency and Bankruptcy Code, which would help stressed portfolios/assets and or shareholders to arrive at a faster resolution process.

9. Gains for ecommerce operators

The Budget has reduced TDS for ecommerce operators from 1% to 0.1%, a move that will benefit startups and technology companies across a range of sectors from food delivery businesses to  ride hailing services. Such a TDS negatively impacted working capital  and the reduction is therefore a positive move. Previously, ecommerce operators were required to withhold TDS at 1% of the transaction value on payments made to ecommerce participants for sale of goods or provision of services through their platforms. 

Consideration received or receivable from non-residents, non-resident ecommerce operators for activities such as online sales of goods, provision of services, sale of advertisements targeting Indian customers, and sale of data collected from Indian residents attracted a 2% equalisation levy. Abolishing the  2% levy helps reduce compliance and ambiguity in this area.