The year 2018 saw a marked progress in the area of fund raising by Indian startups. Investors came rushing in offering millions of dollars. And the valuations of companies too went up substantially. But the income tax authorities might have put a spoke in the wheel, literally by insisting on what is termed as Angel Tax. This is the tax liability the investors have to bear on the funds they invest in startups, where the department feels the company receiving the funds is not valued “fairly”.

Now the prospective investors in startups want to protect themselves by including an indemnity clause in the agreements they enter with the promoters of the startups they invest in. This clause will, inter alia exempt the investor from bearing the tax burden if the income tax authorities were to raise the demand at a later date.

The apprehension is particularly strong with the overseas investors parking their funds in Indian startups. They are not sure of the policies of the government and in an election year, if the government were to change, there could be more uncertainty. Uncertainty is one thing the investors dread.

The real issue relates to the valuation of the startup and this can be seen in many perspectives. There is no tangible value considered at the time of valuations. The startup is valued on the basis of the goodwill it has earned in the market and though the company may be making losses now, the fact that it has invested in creating a customer base and the future business potential are all taken into account. This is a subjective valuation process and the tax sleuths see it in a different perspective and feel the investment at that value attracts the Angel Tax which is a steep 30%+.

The matter is possibly in the discussion stage and the entrepreneurs seeking funds may resist accepting such an indemnity clause. Whether this issue will slow down the startup ecosystem in the country can only be known after some months, if the fundraising efforts are delayed or derailed due to the Angel Tax angle.