In this article, Rituparna Padhy, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on tax exemptions available to a startup.
According to the Nasscom Startup Report of 2017, India is the third largest startup ecosystem, with over 9000 technology startups. To further improve the legal framework for startups, the BJP Government launched the scheme ‘Startup India’ in 2016. The scheme focused on providing tax exemptions to the newly-emerged and upcoming startups in addition to the previously existing taxation laws.
Startup India is a scheme introduced by the Ministry of Commerce and Industry (Department of Industrial Policy and Promotion [DIPP]) of Government of India and supported by the Small Industries Development Bank of India (SIDBI). It was launched on 16 January 2016, with the objective to make India a nation of ‘Nation Creators’ instead of ‘Job Seekers’. The action plan of this initiative is based on three pillars:
- Funding Support and Incentives
- Industry-Academia Partnership and Incubation.
Intending to give motivating forces to new businesses and help their extension in the underlying period of their business, the plan was introduced to give a deduction of 100% of the benefits and increases derived by a qualified start-up that identifies with “innovation development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.”
What is an ‘eligible startup’?
As per the Startup India Action plan, the DIPP has established the followings conditions to be fulfilled by a startup to become ‘eligible’ for tax exemptions:
- Being incorporated or registered in India for less than seven years and for biotechnology startups up to ten years from its date of incorporation.
- The annual turnover not more than Rs. 25 crores in any of the previous financial years (FYs).
- Aims to work towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
- Not formed by splitting up or reconstruction of a business that is already in existence.
- Must have obtained certification from the Inter-Ministerial Board setup for such a purpose.
- Incorporated as a Private Limited Company, or a Registered Partnership Firm, or a Limited Liability Partnership.
Who grants the tax exemptions?
The Inter-Ministerial Board set up by the DIPP validates startups for granting tax benefits. The Board comprises of:
- Additional Secretary, Department of Industrial Policy and Promotion, Convener
- Representative of Ministry of Corporate Affairs, Member
- Representative of Ministry of Electronics and Information Technology, Member
- Representative of Department of Biotechnology, Member
- Representative of Department of Science & Technology, Member
- Representative of Central Board of Direct Taxes, Member
- Representative of Reserve Bank of India, Member
- Representative of Securities and Exchange Board of India, Member.
The above board shall validate startups as being eligible for two tax exemptions.
What are the tax exemptions?
Tax exemptions can come under two categories:
Income Tax Exemption on profits under Section 80-IAC of Income Tax Act
A startup recognized by the DIPP can apply to the Inter-Ministerial Board for “a full deduction of tax on the profits and gains from business as per the Income Tax Act.” The deduction is for “any three consecutive years out of seven years from the year of incorporation of the startup.”
The recognized startup must only be a private limited company or a limited liability partnership and thus registered as per the Companies Act, the Partnership Act, or the Limited Liability Partnership Act. Such a startup, incorporated after 1 April 2016 and before 1 April 2021, can qualify for a 100% tax rebate on profit for a period of three years in a block of seven years, provided that annual turnover does not exceed Rs. 25 crores in any financial year. This is to help the startups to meet their working capital requirements during their initial years of operation.
Income Tax Exemption on investments above fair market value received
A DIPP recognized Startup, being a private limited company, shall be eligible to apply to the Inter-Ministerial Board for exemption from “income tax on investments above fair market value made by resident angel investors, family or funds which are not registered as venture capital funds.”
Provided the following conditions are fulfilled:
- the aggregate amount of paid-up share capital and share premium of the Startup after the proposed issue of shares does not exceed ten crore rupees,
- the investor/proposed investor, who wishes to subscribe to the issue of shares of the Startup has —the average returned income of twenty-five lakh rupees or more for the preceding three financial years, or
the net worth of two crore rupees or more as on the last date of the preceding financial year, and
the Startup has a certified report from a merchant banker that specifies elaborately the fair market value of shares.”
The eligible startups can also apply for tax exemptions under the following categories as per the Startup India Action Plan –
Exemption from tax on long-term capital gains
The Income Act allows eligible startups to exempt themselves from taxation on a long-term capital gain if such a long-term capital gain or a part thereof is invested in a fund notified by Central Government within a period of six months from the date of transfer of the asset. The maximum amount that can be invested in the long-term specified asset is Rs. 50 lakhs. Such amount shall remain invested in the specified fund for a period of 3 years. If withdrawn before 3 years, the exemption will be revoked in the year in which money is withdrawn.
Tax exemption to individual/HUF on investment of long-term capital gain in equity shares of eligible startups
Section 54-GB of the Income Tax Act has now been amended to include an exemption on capital gains invested in eligible startups. Thus, if an individual or Hindu Undivided Family(HUF) sells a residential property and invests the capital gains to subscribe the 50% or more equity shares of the eligible startups, then tax long-term capital will be exempt provided that such shares are not sold or transferred within 5 years from the date of its acquisition. The startups shall also use the amount invested to purchase assets and should not transfer assets purchased within 5 years from the date of its purchase. The ‘new assets’ in the above section shall also include computers or computer software in case of technology driven startups so certified by the Inter-Ministerial Board’s Certification notified by the Central Government in the official Gazette.
Set off of carry forward losses and capital gains allowed in case of a change in shareholding pattern
The carry forward of losses in respect of eligible startups is allowed if all the shareholders of such company who held shares carrying voting power on the last day of the year in which the loss was incurred continue to hold shares on the last day of the previous year in which such loss is to be carried forward. The restriction of holding of 51 per cent of voting rights to be remaining unchanged under Section 79 of the Income Tax Act has been relaxed in case of eligible startups.
Analyzing Startup India Action Plan
Tax collection is typically not the essential worry for most of the new startups who are attempting to make back the initial investment. Since startups don’t make benefits in their initial period, the advantages of a three-year charge occasion are effectively just notional. The Finance Act of 2016 allowed exceptions to long haul capital increases if those are put resources into units of determined assets. The exclusion was likewise allowed for “long terms capital gains arising upon transfer of a residential property if such gains were invested in a start-up eligible as per the recent taxation laws.” Yet, there have been few examples of these advantages being lapped up by the start-up community in the vast majority of the states. Exemption from “angel tax” was a more relevant step as an investment by residents in the eligible start-ups could benefit due to this concession. While this amendment holds potential, it falls short of the intended impact as only “13 start-ups have been certified so far for receiving the said tax benefits.”
The Startup India Action Plan of 2016 focuses on improving the startup ecosystem in India and includes tax exemptions on capital gains and on investments above Fair Market Value. It is noteworthy that the government has thought of separately making startups a focal point of attention, given the entrepreneurial turn the youth is increasingly taking. While the initiative has been effective to some extent, its impact is still restricted because of bureaucratic impediments. The Action Plan should be regularly reviewed and amended so as to accommodate the market demands while maintaining a conducive atmosphere for the startups to prosper.
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