IT department sends notices to startups over unaccounted investments

The notices have been issued under Section 68 of the Income-Tax Act, which specifically deals with unexplained funds that have been credited to the books of tax

The income tax department has recently taken action by sending notices to numerous startups, including some prominent unicorns, regarding unaccounted investments made between FY 2019 and 2021. These startups, which have valuations above a billion dollars, have been requested to provide explanations regarding the nature and source of the funds invested. The tax authorities are focusing their investigation on investments amounting to Rs 100 crore or more, aiming to verify the legitimacy and origin of the funds.

The notices have been issued under Section 68 of the Income-Tax Act, which specifically deals with unexplained funds that have been credited to the books of taxpayers without proper sources being disclosed. This section is primarily invoked to determine the identity, creditworthiness, and genuineness of share issuances.

Notably, the income tax department's notices have raised queries about the local holdings of foreign investors, the methodology used for valuation, and the purpose of loans obtained by the investors. These inquiries are driven by concerns about the round-tripping of funds, leading to the extension of the angel tax provision to non-resident investors.

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To address these concerns, a negative list of exemptions from angel tax provisions has been prepared, taking into consideration the regulatory framework. Sovereign wealth funds, pension funds, and Sebi-registered portfolio investors from 21 jurisdictions are among the entities exempt from angel tax provisions due to their status as regulated entities.

Sources familiar with the matter have reported that the government has received suggestions from private equity and venture capital (PE/VC) funds to relax the terms and conditions related to angel tax. These recommendations aim to broaden the scope of exemptions and simplify regulations. For instance, there is a proposal to extend the exemptions currently applicable to stocks for price matching and the 10 percent safe harbour to also include convertible bonds.

However, it is essential to note that this proposed change, primarily related to tax, could potentially impact foreign investment deals under forex rules. Inbound private equity transactions often involve the use of convertible securities, such as compulsorily convertible preference shares with a conversion ratio. If these securities are issued at a price higher than their valuation price, the difference between the two amounts may be subject to angel tax.

In conclusion, the income tax department's issuance of notices to startups regarding unaccounted investments reflects their commitment to ensuring transparency and accountability in financial transactions. By scrutinizing investments and seeking explanations, the department aims to combat illicit financial activities and promote a robust and regulated investment ecosystem. Startups and investors should be aware of the implications of such notices and adhere to the regulatory requirements to avoid any potential legal and financial consequences.

Also Read: How Bengaluru became the Silicon Valley of India : The Real Story
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