India Budget 2013-14 : Impact on Angel Investors and Startups

We had shared this note privately to many of the angels and startups who are raising investment. And then, quite a few interesting conversations emerged. Sharing here for the larger audience.

Here’s the link to the Budget Speech http://indiabudget.nic.in/bspeecha.asp. The references made below are to this Speech.

Angel Investors pooling in money and obtaining SEBI registration as Category I AIF Venture Capital Fund shall be given a pass through benefit from Income Tax perspective.

Two important references in point 95 and point 143.

‘Pass through’ means the legal entity (which has pooled the money) need not pay taxes and the same is taxed in the hands of the LPs.

In May 2012, SEBI repealed the VC Regulations and brought in Alternate Investment Fund Regulations (AIF Regulations). Under AIF there are three categories. Category I AIF is the one relevant for our discussion here, which  invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds.

Further, AIF Cat.I has a minimum pool size of Rs. 20 crores and each LP’s ticket size of Rs. 1 crore amongst other requirements.

The point is, Angel Investors will have to meet the SEBI registration requirements in order to obtain the tax benefit.

The Finance Act 2012 brought in an amendment to tax the share premium which is above the fair value of investment by the resident angel investors and not proven satisfactorily to the tax assessing officer.  This amendment is effective 1 April 2013.  The hope was this would be reversed, but no.

Text of Points 95 and 143 of the Budget Speech:

95. Angel investors bring both experience and capital to new ventures.  SEBI will prescribe requirements for angel investor pools by which they can be recognised as Category I AIF venture capital funds.

143.        Venture Capital Funds have been allowed pass through status under the Income-tax Act.  The relevant regulations of SEBI have been replaced by Alternative Investment Fund Regulations.  Hence, I propose to extend, subject to certain conditions, pass through status to category I Alternative Investment Funds registered with SEBI as venture capital funds. Angel Investors who are recognised as category I AIF venture capital funds will also get pass through status.

Incubators

Incubators located within academic institutions and approved by Ministry of Science and Technology or MSME can now raise money from large corporate and the corporate get the benefit of its CSR obligation (Corporate Social Responsibility).  The CSR obligation is proposed in the Companies Bill 2012, which is passed at Lok Sabha and awaits approval from Rajya Sabha (expected in a couple of months) and the President’s assent for it to be an Act (legislation).

Under the Companies Bill, corporate (private and public) that make an average profit of at least Rs 5 crore  or have a worth exceeding Rs 500 crore, or their turnover exceeds Rs 1,000 crore in the last three years will have to spend 2% of the net profits in CSR.

So, apart from DST and DIT funds the incubators can now also get funding from large corporate. It also appears that there is an approval process required by  the Ministry of Science and Technology or Ministry of MSME

Text of point 76 of the Budget Speech

76. Incubators play an important role in mentoring new businesses which start as a small or medium business.  The new Companies Bill obliges companies to spend 2 percent of average net profits under Corporate Social Responsibility (CSR).  I am glad to announce that the Ministry of Corporate Affairs will notify that funds provided to technology incubators located within academic institutions and approved by the Ministry of Science and Technology or Ministry of MSME will qualify as CSR expenditure.

Exit opportunities:

Company buyback: Company will have to pay 20% tax on such buyback.  There was no tax incidence on company buy-back.

The consideration paid by the company for purchase of its own unlisted shares which is in excess of the sum received by the company at the time of issue of such shares (distributed income) will be charged to tax and the company would be liable to pay additional income-tax @ 20% of the distributed income paid to the shareholder. The additional income-tax payable by the company shall be the final tax on similar lines as dividend distribution tax. The income arising to the shareholders in respect of such buy back by the company would be exempt where the company is liable to pay the additional income-tax on the buy-back of shares.

Listing: The listing process under BSE-SME exchange is further simplified for startup companies.  The Listing norms for the SMEs (at a very high level) are as below.

  1. Net Tangible assets of at least Rs. 1 crore as per the latest audited financial results
  2. Net worth (excluding revaluation reserves) of at least Rs. 1 crore as per the latest audited financial results
  3. Track record of distributable profits in terms of sec. 205 of Companies Act, 1956 for at least two years out of immediately preceding three financial years and each financial year has to be a period of at least 12 months. Extraordinary income will not be considered for the purpose of calculating distributable profits. Other wise, the networth shall be at least Rs 3 Crores.
  4. Other Requirements:  (i) The post-issue paid up capital of the company shall be at least Rs. 1 crores (ii) The company shall mandatorily facilitate trading in demat securities and enter into an agreement with both the depositories (iii) Companies shall mandatorily have a website

The Finance Minister in the Budget provided for listing on the SME exchange without having to make an IPO.

95. Small and medium enterprises, including start-up companies, will be permitted to list on the SME exchange without being required to make an initial public offer (IPO), but the issue will be restricted to informed investors.  This will be in addition to the existing SME platform in which listing can be done through an IPO and with wider investor participation.

FDI versus FII:

There has always been some confusion on FDI and FII and this time around there seems to be (somewhat arbitrary) explanation provided by the FM.  The RBI regulations reference “FDI” limits, so we’ll now need to evaluate if this clarity adds to a whole lot of other confusion.

Text of sub-point under point 95

In order to remove the ambiguity that prevails on what is Foreign Direct Investment (FDI) and what is Foreign Institutional Investment (FII), I propose to follow the international practice and lay down a broad principle that, where an investor has a stake of 10 percent or less in a company, it will be treated as FII and, where an investor has a stake of more than 10 percent, it will be treated as FDI.  A committee will be constituted to examine the application of the principle and to work out the details expeditiously.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

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