28 Feb, 2025
4 mins read
Angel tax has been a significant topic in India's startup ecosystem. It impacts how startups raise funds, often posing challenges for budding entrepreneurs. But what is angel tax, how does it work, and what changes have been made recently? Let's explore these aspects in detail.
Angel tax refers to the tax levied on the funds raised by unlisted companies through the issue of shares to investors at a price exceeding the fair market value (FMV) of the shares. The excess amount is considered income and taxed under Section 56(2)(viib) of the Income Tax Act, 1961.
In simpler terms, if a startup issues shares at a price higher than what the government considers their fair value, the extra amount is taxed as income. This tax came to be known as "angel tax" because it primarily affects angel investors who invest in early-stage startups.
Angel tax in India is applied when a startup raises funds from domestic or foreign investors at a premium above the FMV. The excess premium is treated as income from other sources and taxed accordingly.
Here’s how it works:
This taxation discouraged angel investments because determining FMV is subjective, and startups often raise funds at valuations based on future potential rather than current revenue.
Angel tax was introduced in 2012 to curb money laundering and prevent the inflow of unaccounted money into startups under the guise of equity investments. The government wanted to ensure that investments were legitimate and not used as a loophole for converting black money into white.
However, the tax created hurdles for genuine investors and startups. It slowed down the fundraising process, especially for early-stage startups that rely heavily on angel investments.
The angel tax rate in India was aligned with the income tax slab applicable to the entity. Typically, startups had to pay tax at the rate of 30% (plus applicable surcharge and cess) on the excess amount over FMV.
For Example:
If the excess amount (premium) was ₹10 lakh, the angel tax payable could be ₹3 lakh or more, depending on applicable surcharges.
This high taxation rate made it difficult for startups to raise funds, as a significant portion of the investment would go toward taxes instead of business growth.
Recognising the impact of angel tax on startups, the Indian government introduced exemptions. The angel tax exemption for startups was available if:
In July 2024, the government went a step further and abolished the angel tax altogether for all classes of investors, effective from the financial year 2025-26. This decision was aimed at boosting startup investments and aligning India’s policies with global standards.
Let’s understand angel tax with an example:
Scenario Before Abolition:
With the abolition of the angel tax, the ₹30 lakh excess amount is no longer taxed. Startups can now raise funds without the fear of losing a portion of investments to taxes, encouraging a healthier investment ecosystem.
Understanding what is angel tax is crucial for anyone interested in India’s startup ecosystem. While angel tax once posed challenges by taxing investments above the fair market value, its abolition in 2024 has significantly improved the investment climate. This move is expected to foster innovation, attract global investments, and support India’s growth as a leading startup hub. With no more concerns about angel tax rates in India or complicated exemption processes, startups can now focus solely on scaling their businesses and achieving success.
Angel tax is the tax levied on the excess premium received by unlisted companies when issuing shares above their fair market value. It was introduced in 2012 to prevent money laundering and the circulation of unaccounted money under the guise of investments.
Angel tax discouraged startup investments by taxing the premium received over the fair market value. This created uncertainty for investors and limited startups' ability to raise funds based on future potential rather than current valuations. However, its recent abolition has removed these hurdles.
Before its abolition, startups recognised by DPIIT, with total paid-up capital and share premium not exceeding ₹25 crores, and investors meeting certain income or net worth criteria, were eligible for exemption. Now, with the complete removal of the tax, all startups and investors are free from this burden.
Previously, startups could avoid angel tax issues by:
Now, with the angel tax abolished, startups no longer face these issues, making it easier to secure investments.
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