Government Weighs Exempting Overseas Funds From Complying With Angel Tax Rules

In February, the Union budget proposed to bring foreign investors under the ambit of the controversial section that applies to the premium paid over a company’s so-called fair market value when raising capital. The provision will come into effect from 1 April 2024 and remains unchanged in the Finance Bill for the year starting 1 April.

Currently, Section 56.2.Vii b exempts domestic Alternative Investment Funds regulated by the Securities Exchange Board of India (Sebi) and the International Financial Services Centre Authority.

A senior official aware of the details said that, “Rules on angel tax that will come out next month will specify the carve out for certain foreign entities who are genuine investors."

Another official said that concerns raised by stakeholders in the implementation of the proposal would be addressed.

The first set of foreign funds that are likely to be exempted are sovereign wealth funds such as Abu Dhabi Investment Authority, GIC, and Qatar Investment Authority—as there is concern that the threat of Section 56.2 Vii B tax could adversely impact foreign investments, which could jeopardize the government’s infrastructure investment push. The Union budget 2020-21 introduced several tax concessions specially targeted at sovereign wealth funds to shore up infrastructure investments.

Foreign funds such as KKR, Softbank and Sequoia Capital are also likely to be exempted from Section 56.2.Vii b, the second person familiar with the details added.

The notification exempting overseas funds would be clarifying for the ecosystem, which drew in over $130 billion in private capital over the last two years. Foreign PE/VC funds announced investments worth $77 billion in 2021, which dropped slightly in 2022 to around $54 billion, according to EY. The startup ecosystem, which disproportionately depends on foreign capital and typically issues shares at a premium to the fair market value (FMV) on the promise of future growth, was particularly concerned that the new amendment in Section 56.2.Vii b could be applied for foreign investment.

This would have treated a fundraise as additional income, which would attract corporate tax.

The section, which came to be known as ‘angel tax’ because of its disproportionate impact on startups, was first introduced in 2012 as an anti-tax abuse measure and treated the difference between the premium and the FMV as income. 

“The startup ecosystem still holds hope for exemptions to international institutional investors like VC funds, sovereign wealth funds, etc. The central government is empowered to do so via notification. The hope is that the notification comes before 1 April 2023 so that ongoing funding rounds aren’t dislocated," said Siddarth Pai, founding partner of 3one4 Capital and co-chair of the Regulations Affairs Committee of industry body Indian Venture and Alternate Capital Association.

On 3 February, DPIIT (department for the promotion of industry and internal trade) secretary Anurag Jain clarified that the tax would not apply to DPIIT-registered startups.