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Funding a Start-up in India to be classified as Taxable income!

A recent clause in India’s 2012 Budget proposes taxing Indian start-ups 30% of the amount invested by Angel investors by terming the investment as income.

The Memorandum of the Finance Bill 2012 states
“It is proposed to insert a new clause in section 56(2). The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income tax under the head “Income from other sources. However, this provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.”

Where does this leave entrepreneurs who get Angel funding pretty early in the start-up life cycle when perhaps the only assets they have is a great idea on its way to execution?

In the Hindu Businessline, Mr Saurabh Srivastava, co-founder of Indian Angel Network, explains: “An angel investor may invest Rs 1 crore in a company that has no revenues and no profits and the tax official, unless otherwise ‘persuaded’, would tax the company at 30 per cent for no reason at all and convert an investment into income.”

Possible ways of working around this clause are suggested by Deepak Shenoy, who is a co-founder at MarketVision. He says, ” If you are a founder, you could use a sweat equity approach or use convertible debentures or since the law applies only to companies, you might be able to start a Limited Liability Partnership. Read his in-depth analysis here.

On a similar note, the U.S is mulling passing the “Entrepreneur Access to Capital Act,” (Pdf Link) which allows entrepreneurs to raise up to $2 million from individual investors without having to be approved by securities regulators. You can read more about this on his blog here.

I have rarely seen online petitions change anything in India, yet I am hopeful and have signed a petition. If you would like to do the same, you can do so at http://www.ipetitions.com/petition/no-startup-tax/

What do you think about the proposed law?

3 comments on “Funding a Start-up in India to be classified as Taxable income!

  1. Very interesting read🙂

  2. so does this mean that any investment being made on a startup are taxed at flat 30% ? If so, that’s not a good approach by the govt, in my opinion. Its the time where India has to encourage startups and entrepreneurs.

  3. Well It was proposed to be completely taxable on any amount invested, but after intervention by prominent people from the start-up community, now the Finance Minister is proposing that up to Rs 10 crore wont be taxed under this scheme. Anything above that will be.

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