With a view to encourage entrepreneurship and boost the startup ecosystem in the country, a plethora of tax exemptions and tax relief have been announced under the ‘Startup India’ policy. Startups are always on the lookout for funds. These incentives are a way for the companies to save money and use it to further their business plans. By implementing these incentives the Government hopes to build a strong startup ecosystem and nurture innovation and in the process drive sustainable economic growth and generate employment.
The Startup India initiative was announced by the Indian Prime Minister Mr. Narendra Modi on August 15, 2015 to promote and support the startups in the country. This scheme defines the eligibility criteria for a startup and also benefits and exemptions available to the entities if they qualify as ‘Eligible Startups’.
What is a Startup?
According to the Department for Promotion of Industry and Internal Trade (DPIIT), an entity will be considered a startup only for a period of ten years from its date of incorporation if it fulfils the following conditions
- It should be incorporated as a private limited company, partnership or an LLP.
- Annual turnover of the entity should not exceed INR 100 crores in any of the financial years since incorporation.
- The entity should not have been formed by splitting up or reconstructing an already existing business.
- The entity should be involved in innovation of products or processes with high potential for employment generation or wealth creation.
Following are the tax exemptions available to eligible startups.
- Corporate Tax Holiday
Startups incorporated after April 1, 2016 can avail 100% tax rebate on profits for a period of three years in a block of 7 years (10 years from April 1, 2021) under Sec 80-IAC of the Income Tax Act.
In order to be eligible to claim this deduction the startup must fulfil the following conditions
- It should be only a company or a LLP
- The entity must be incorporated after April 1, 2016
- Its turnover must not exceed INR 25 crores (100 crores from April 1, 2021) in any financial year for which the deduction is claimed.
- The entity must hold a certificate of eligible business from the Inter-Ministerial Board of Certification
- Relief from Angel Tax
When an unlisted company raises funds by issuing shares to Indian residents at a price more than its fair market value then this excess amount received is taxable as income from other sources in the hands of the issuer. This tax charged on the excess amount is called Angel Tax. Angel Tax comes under Section 56 (2) (vii b) of the Income Tax Act under Measures to Prevent Generation and Circulation of Unaccounted Money. The government has exempted the tax levied on investments above the fair market value in eligible startups.
Valuation of the shares for this Sec 56 (2) (vii b) is done at the option of the assesse an could be the book value or the value arrived at the discounted cash flow method.
Startups can avail exemption from levy of angel tax if they meet the following conditions
- The startup should be registered with DPIIT
- The aggregate amount of paid-up share capital and share premium after issue of shares does not exceed INR 25 crores. This however does not include issue of shares to a non-resident company, a venture capital company, venture capital fund, Category I and II Alternative Investment Funds, and a listed company whose net worth exceeds INR 100 crores or turnover exceeds INR 250 crores for the financial year preceding the year in which the shares are issued.
- The startup does not invest in the assets as specified and prohibited by the DPIIT for a period of 7 years from the end of the latest financial year in which the shares are issued at a premium.
- Relaxed Provisions for Set Off and Carry Forward of Losses
The provisions for set off and carry forward of losses in the case of eligible startups have been provided by the Finance Act, 2019.
According to this Act, a closely held eligible startup can carry forward the losses incurred within 7 years of incorporation and set it off against the income of the previous year as long as it satisfies one of these conditions
- There is continuity of 51% shareholding
- There is continuity of 100% of original shareholders.
- Capital Gain Tax Exemption under Sec 54GB and 54EE
In order to encourage investment in eligible startups and promote their growth and expansion Sec 54GB has been modified to include exemption on capital gains invested in an eligible startups.
Tax exemption is available when an individual sells a residential property and invests the capital gains to subscribe to50% or more of the equity shares. In such cases tax on long-term capital gain is exempt provided the share are not sold or transferred within 5 years from the date of its acquisition. The startup should also not transfer the asset within 5 years from the day of purchase and must use the amount invested.
Sec 54EE is a new section inserted in Income Tax Act for eligible startups. According to this provision, a startup is exempt from paying tax on long-term capital gain if such a long-term capital gain or a part of it is invested in a fund notified by the Central Government within a period of 6 months from the date of transfer of the asset. The maximum amount that can be invested in the specified fund is INR 50 lakhs and the amount shall be invested for a period of 3 years. Failure to do so will cause the withdrawal of the tax exemption.
- ESOP Taxation Benefit
Sec 192(1C) has been introduced in Finance Act 2020 for relaxing the taxability of ESOP. According to the new provisions, ESOPs of employees working in startups will be liable for tax in any one of the following cases whichever is earlier
- Five Years after Exercising the Option
- The Year in which they sell their shares
- The year when the employee leaves the company
This proposed five-year deferment of tax payments on ESOPS helps the startup to attract more skilled employees.
In the earlier system employees were subject to tax in the year in which they exercised their option to purchase the shares. This meant the employees paid tax despite not making any cash gain. Instead of collecting taxes early, the new provisions have a five-year deferment period for collecting taxes.