The recent budget announcement of scrapping angel tax, which has impacted India’s startup ecosystem, is expected to provide an incentive to high net worth individuals, family offices and foreign venture capitalists to loosen their purse strings and is seen as a boost to investor sentiment.
Still, investors are cautious about the decision’s immediate impact on fundraising volumes, expecting any increase to be gradual.
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“No foreign investor wants to invest in a country where there is a risk that their investment will be arbitrarily treated as taxable income (startups). This measure (abolition of angel tax) will streamline the investment process, reduce ambiguity around tax treatment and encourage foreign investment in Indian startups,” said Anirudh A Damani, managing partner at micro venture capital fund Alta Venture Fund.
Finance Minister Nirmala Sitharaman last week announced the scrapping of angel tax while presenting the Union Budget for 2024-25, noting that the tax will no longer be applicable to companies raising capital after April 1, 2024. The angel tax was introduced in 2012 to prevent tax evasion and misuse of funds.
After Sitharaman’s announcement, Rajesh Kumar Singh, secretary of India’s Department of Promotion of Industry and Trade (DPIIT), said the decision could help bring an end to the funding winter gripping India’s startup industry. “Venture capitalists, high net worth individuals (HNIs), foreign investors — who have been hesitant to invest in startups due to tax liability — will now be a little more proactive,” Singh told the Business Standard last week.
Funding for Indian startups is expected to fall 72% year-on-year in 2023 to $7 billion, the lowest in seven years, from $25 billion a year earlier, according to data from market intelligence platform Tracxn.
“Earlier, venture capitalists, high net worth individuals and foreign investors faced a compliance nightmare. This move will remove this burden and create a more attractive fundraising environment,” said Ankit Kedia, founder and lead investor at early-stage investment firm Capital A.
Moreover, the abolition of angel tax is expected to speed up the investment process by reducing the need for extensive paperwork and valuation reports. “Reducing the time lag between an investor’s investment decision and the completion of the investment will allow funds to reach deserving startups faster. This accelerated flow of investments will undoubtedly help ease the fundraising winter,” Damani said.
But investors caution that they don’t expect the repeal of the angel tax to make a dramatic difference to overall deal volume right away. “I don’t think this will have a dramatic impact on fund flows right away, but there will definitely be some improvement in terms of reducing friction,” said Vinod Murali, co-founder and managing partner at venture debt fund Arteria Capital. “It’s like removing a roadblock. Ultimately, investors have to be willing to write a check for startups that deserve investment. This measure reduces friction… In an environment where fundraising is not that easy, the fewer obstacles the better.”
While the repeal of the angel tax is a major win for startups and investors, the ecosystem is not without its challenges. “There are other challenges, including complex regulatory requirements, ever-changing tax regimes, and multiple license and permit requirements, all of which can be time-consuming and costly,” Kedia said.
Investors continue to point out the lack of a “clear and consistent” framework for foreign investments and the associated stringent reporting norms. The need to file multiple tax returns, keep extensive documentation and comply with complex tax laws often delays operations and increases costs. “Starting, running and closing a business in India remains extremely cumbersome. While there have been some improvements in this regard, there is still a long way to go in terms of making founders’ lives easier,” Murali noted.
As a result, industry participants are calling on the government to streamline the regulatory process, provide clearer guidelines on tax and investment policies, and establish a more predictable legal framework.
