Re­peal an­gel tax

Rewrit­ing Sec­tion 56 (2) to ex­clude start-ups is dif­fi­cult

Business Standard - - OPINION -

The govern­ment is re­port­edly plan­ning to raise the in­vest­ment limit for avail­ing in­come tax con­ces­sions by start-ups, and pro­vide a clearer def­i­ni­tion. The Depart­ment for Pro­mo­tion of In­dus­try and In­ter­nal Trade (DPIIT) has de­cided to form a work­ing group to re­solve the “an­gel tax” tan­gle. These are wel­come de­vel­op­ments as they sig­nal that pol­i­cy­mak­ers are be­com­ing aware of the ma­jor is­sues caused by Sec­tion 56(2) of the In­come-Tax Act. But while the Cen­tral Board of Di­rect Taxes (CBDT) has de­cided to go slow on de­mands un­der the sec­tion, and a mech­a­nism for ex­emp­tions has been cre­ated, more than 2,000 start-ups have al­ready re­ceived in­come-tax no­tices. Last week, two start-ups com­plained that their com­pany ac­counts were frozen by the tax depart­ment and money with­drawn on ac­count of an­gel tax de­mands. Though the CBDT later clar­i­fied that these were not re­lated to an­gel tax, the fear fac­tor per­sisted.

How­ever, a last­ing so­lu­tion to the prob­lem is delet­ing the con­tentious clause. In­dus­try stake­hold­ers, tax ex­perts and the DPIIT it­self have rec­om­mended the clause be scrapped. And, the govern­ment’s plan to come up with a def­i­ni­tion of a start-up sounds good on paper, but may prove to be a dif­fi­cult task. The is­sue with the Sec­tion arises from the con­cept of tax­ing closely-held, un­listed com­pa­nies, which is­sue shares at above “fair value”. The dif­fer­ence be­tween share price and “val­u­a­tion” is taxed as in­come. This pro­vi­sion is sup­posed to pre­vent money laun­der­ing and to de­tect money be­ing si­phoned off into shell com­pa­nies. Un­for­tu­nately, there is no hard and fast rule for valu­ing start-ups. Val­u­a­tions are es­pe­cially dif­fi­cult in a ser­vice-ori­ented econ­omy where new busi­nesses are as­set-light. An­gel in­vestors ap­ply a com­bi­na­tion of art and sci­ence to es­ti­mate growth while in­vest­ing in start-ups. En­trepreneurs and in­vestors ac­cept this equa­tion of high risk and high re­ward. Re­peated tax no­tices add an un­nec­es­sary el­e­ment of stress to an al­ready high-risk ecosys­tem. An­other trou­bling od­dity is that this Sec­tion is dis­crim­i­na­tory in that start-ups rais­ing eq­uity abroad are not sub­ject to this scru­tiny. Given the fram­ing of the Sec­tion and the dis­cre­tionary pow­ers of of­fi­cers as­sess­ing val­u­a­tions, no­tices are more likely than not for In­dian-funded star­tups. It is es­ti­mated that over 70 per cent of start-ups, with In­dian in­vestors, have re­ceived IT no­tices.

The ex­emp­tion process is cum­ber­some, in­volv­ing ap­pli­ca­tions with lots of pa­per­work to the DPIIT, which has the dis­cre­tion to rec­om­mend ex­emp­tions to the CBDT. Rewrit­ing the Sec­tion to ex­clude start-ups from its am­bit is eas­ier said than done. How does one de­fine a start-up, and dis­tin­guish it from a newly reg­is­tered shell com­pany? On paper, a newly reg­is­tered shell com­pany is in­dis­tin­guish­able from a bona fide start-up un­til it has started gen­er­at­ing rev­enues. There are other tried and tested ways to iden­tify money laun­der­ing. In­deed, the govern­ment claims that it has dereg­is­tered mil­lions of shell com­pa­nies in the last four years. Money laun­der­ing and tax eva­sion are per­ni­cious prac­tices that need to be elim­i­nated. But the start-up ecosys­tem is vi­tally nec­es­sary for gen­er­at­ing busi­ness ac­tiv­ity, and for cre­at­ing em­ploy­ment. The an­gel tax clause must go if it can­not be rewrit­ten to ex­plic­itly ex­clude star­tups from this form of tax ter­ror­ism.

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