Income tax department is planning to tax startups whose valuation has been slashed. Section 56 of the Income Tax Act confers the tax department the ‘power to tax the excess consideration’ (more than the fair value) against issue of shares in the last round of funding.
Fair value is the actual value of the Company. Few startups valuation has been slashed on parameters such as profitability, growth, and intense competition, which was not considered before, thus making the company overvalued in earlier rounds of funding. The income tax department is of the opinion that considering the current slashed down valuations as the fair price of the company, the differential amount of the funds raised in earlier rounds at a higher valuation are taxable.
How it Impacts Startups Raising initial funding is not easy for startups and this extra tax only adds to the problems. Valuation of startups is based on only assumptions as there is no past data for assurance. This tax will cause fear in term of valuation in startup world. In the initial stages, startups struggle with fund requirements at every step and the extra tax burden is going to increase the pressure further. Startups are too vulnerable and the money crunch can lead to hampered operations or even shutting down shops.
It is a summarization of an article from Your Story. For more information, visit http://yourstory.com/2016/06/startup-tax/