Why Startups are facing Tax Notice these days!!!

Companies used to issue shares at high premium usually above the book value. Due to this promoters/directors/related persons were able to convert their black money into white by receiving shares of companies.Consideration for these shares were used to be paid in black money.

#Lets understand the above scenario with the help of a live example:

Fliptip a start up received first round of funding 6 months back. Fliptip issued 10,000 shares at Rs 7000 per share, aggregating to Rs7,00,00,000/-.Valuation at Rs7000 per share was substantiated by detailed reports of merchant bankers and chartered accountants.

Now during 6 months Fliptip incurred heavy losses due to excessive discounts and intense competition. It went for 2nd round of funding. But this time share was valued at Rs 5000 only. Lower valuation by merchant bankers and chartered’s was due to loss in market share.

#BUT Why Tax Officials are issuing notice to such startups??

Tax officials suspects that during last round valuations were increased in order to issue shares at excess premium to few resident investors.Such investors used startups to convert their black money into white.

#Which all Startups will receive Notice from I.T Department??

Only those Startups will receive notice that received funding from Resident Individual investors. Often these investors are known as Angel Investors

Startups which received funding from following will not receive tax notice:

a. Foreign Investors &

b. Venture Capital Fund registered with SEBI

#What’s our take??

1. Sending out random notices to startups to furnish data is unnecessary and reduces the ease of doing business. Instead of sending notice to startups, tax officials shall inquire from resident investors about the source of their funds. If some discrepancy is found at resident investor level, tax can be levied on such investors by invoking provisions of Section 68 of the Act.

2. In countries like the US, an angel investor often gets angel tax credits of about 25% of their investments made in startups. 

3. Fair market value can change in both directions over time. Hence, the notion of using drop in value as an opportunity to tax prior transactions is perverse at best.