This article is written by Sakshi Prem, pursuing a Certificate Course in Advanced Corporate Taxation from LawSikho.com. Here she discusses “How did tax exemptions change for Start-ups in 2018?”.
Start-ups are of a certain nature- usually starting off as small businesses, owned by a small number of people, looking for investment to take their business to the next level. With the growing number of start-ups that were emerging, the Start-up India initiative was kick-started by the Government of India in January 2016. An action plan was set up to make the market conducive for the growth of start-ups and which promised certain incentives including tax benefits to attract the creation of new Start-ups. In pursuant of this, the Finance Ministry has come out with multiple policies to benefit the ecosystem.
Changes through Notifications
The DIPP issued numerous notifications post the establishment of the Start-up India initiative. The Notification dated 11th April 2018 remains the most significant one, which laid down what entities constituted start-ups, how they should register themselves and how to avail tax benefits specifically with respect to the Section 56 provision. Some of the significant revisions are listed below.
The DIPP issued a notification establishing what entities constituted start-ups and what tax benefits they received. Any kind of incorporated private company or partnership firm, up to 7 years from their incorporation, was established as a start-up. The Biotechnology sector was accorded a 10-year period from their incorporation.
Further, the start-ups should be working towards innovation, development or improvement of goods and services. Additionally, they should not have had a turnover of over twenty-five (25) crore rupees in any financial year. However, it is to be noted that an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.
Constitution of an Inter-Ministerial Board
On meeting these requirements, an application of exemption has to be made to an inter-ministerial board consisting of officials across over eight different government departments for the start-ups to obtain an exemption. These measures have proven to be extremely cumbersome and time-consuming to the start-ups.
To be recognized as a start-up, new procedural guidelines were introduced as follows:
(i) an online application was to be made through the mobile app or portal set up by the DIPP
(ii) The application was to enclose: (a) a copy of Certificate of Incorporation or Registration, and (b) a note on the nature of business highlighting how it is working towards innovation, development or improvement of products or processes or services, or its scalability in terms of employment generation or wealth creation.
The DIPP after reviewing the documents and making enquiries, may recognize the applicant as a start-up or reject it after providing reasons.
Change in the procedure to apply for Section 80-IAC relief
An application through Form 1 can be made for the issuance of the certificate under Section 80-IAC of the ITA,1961, for the purposes of obtaining a tax holiday for the first 3 years of an eligible start-up. It has to contain the name of the start-up, date of incorporation, PAN, Address etc. Annual Financial Statement and Copies of the Income-tax returns for the past 3 years should be attached with the form as well.
Section 56 relief
The most significant aspect of this notification was with respect to the Angel Tax Provision.
To provide a little background, as a principle, investments/capital income are not taxed under the Income Tax Act, 1961 (hereinafter “the Act”), as it is considered to be an asset and income that is taxable at a later stage – in the form of dividends or capital gains. However, with the insertion of Section 56(2)(viib) in the Act by the Finance Act 2012, any investment made by a resident, in premium, exceeding the Fair Market Value (FMV) of the shares are to be taxed to the extent of the premium. This was done in pursuance of the initiative by the then finance minister, Shri Pranab Mukherjee to counteract the “malaise of generation and circulation of black money”. This provision was introduced in the Act along with provisions such as the General Anti-avoidance Rules (GAAR) and the inclusion of Specified Domestic Transactions within the ambit of the transfer pricing provisions, in furtherance of the same motive.
This section has cost the lifeline of start-ups very heavily at the rate of 30% of the premium investment raised. Hence, after hearing a lot of outcries, the CBDT notification, via the power conferred to it by proviso (ii) of Section 56(2)(viib) of the Act, exempted investments from a certain ‘class of persons’. It exempted investments from resident ‘persons’. The ambit of persons is defined under S.2(31) of the Act. This was seen as a major relief to investors and start-ups alike. However, foreign investments were still taxed.
Additionally, even post the notification from the CBDT, notices were sent to start-ups to pay a massive 30% income tax on premium investments received by them. Relief accorded was quickly snatched away from the start-ups and many were in a state of panic. Thus, began a back and forth game between the start-ups and the various government departments.
The notification dated 11th April 2018 granted an exemption to registered start-ups under the section, if the investment fulfilled certain guidelines. The guidelines stipulated the investment made in premium to be below ten (10) crore rupees and further cast a mandate upon the investor to have an average returned income of at least twenty-five (25) lakh rupees or have a net worth of over two (2) crore rupees as on the preceding financial year. It further mandated a report from a merchant banker as under Rule 11UA of the Rules. It is to be noted here that chartered accountant was removed from being able to value unquoted shares under Rule 11UA(2)(b) via a notification from the CBDT notification dated 24th May 2018. These measures were taken to avoid falsification of valuation.
However, it is to be noted that stakeholders in the Start-up industry, were not happy with this notification as the financial thresholds for attracting tax liabilities remained low. Hence, after subsequent requests from the industry, the Ministry made further revisions. The latest notification exempts registered start-ups for up to 10 years from incorporation/registration, which maintain a turnover below 100 crores in every financial year and issues share capital worth less than 25 crores. However, the exemption comes with conditions that start-ups cannot invest in capital assets and securities, among other things, for a period of 7 years post the exemption period, which is a major limitation for start-ups.
Changes through the Budget 2018
Corporate Tax Rate Cut
The budget of 2018 brought with it a relief for small and medium-sized companies in India. Especially Start-ups. The corporate tax rate was cut from 30% to 25% for companies with a turnover of up to 250 crores in FY 2016-17. This is a significant amount of money saved for Start-ups, which can boost their business performance. This reduces the cost of doing business, which means more funds can go back into investing in the growth of the Start-up.
Amendment in Section 80IAC
Section 80IAC provides a tax holiday for eligible start-ups for profits up to 3 consecutive years. The Budget extended the period of incorporation of start-ups from 1 April 2016 to – 1 April 2019 to 1 April 2016 to – 1 April 2021 to be eligible to avail benefits under Section 80 IAC of ITA. This brings within the bracket of benefit, a larger number of start-ups. Further, now eligible start-ups can claim a tax holiday for any 3 years out of their 7-year status as a start-up. The 7-year period is counted from the date of incorporation.
Exemption on Salary up to 40,000
The Standard Deduction for salaried individuals was reintroduced and granted INR 40,000, in place of travelling and medical allowances. This does not create substantial benefits for medium or large-sized companies which give relatively higher salaries. But for smaller start-ups, this comes as a great relief for its workers. Thus, increasing the supply of job applicants and indirectly helping start-ups grow.
No Education Cess on the Import of goods abolished
Education Cess and Secondary and Higher Education Cess were abolished on the import of goods. Although nominal, it a boost for start-ups in the sector of import of goods.
The government introduced a contribution of 12% of wages for new employers towards EPF across all sectors for the next 3 years. This helps start-ups by reducing their financial liabilities.
As can be seen through the above illustrations, a wide range of policies and regulations were changed in 2018 for start-ups, to promote and accelerate our economy. The government sees the massive potential hidden in the start-up ecosystem. India is expected to become a $10-trillion economy by 2030, and start-ups are the seeds to this grand idea.
- DIPP Notification No. G.S.R. 364(E).
- Section 56(2)(viib), Income Tax Act 1961.
- CBDT Notification No. 45/2016, 14th June 2016.
- CBDT Notification No. 23/2018/ F.no. 370142/5/2018- TPL, 24th May, 2018.
- DPIIT Notification No. G.S.R. 127(E), 19th February 2019.
- Mohandas Pai, ‘Angel Tax: Will The Wicked Consume The Righteous?’ (BloombergQuint, 2019), accessed at: https://www.bloombergquint.com/opinion/angel-tax-will-the-wicked-consume-the-righteous.
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