Income Tax 21 Jan,2020
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Pre-Budget 2020: Expectations of Start-ups
Tarun KumarChartered Accountant

Start-up India campaign was formally launched by Prime Minister Shri Narendra Modi on January 16, 2016 from Vigyan Bhawan, New Delhi. Indian Start-ups have come a long way as we have marked 5-year journey of Start-up India initiative. Finance Minister Smt. Nirmala Sitharaman is all set to present the second budget of Modi 2.0. Start-up Industry shall be expecting reforms that bring in more transparency and critical steps towards ensuring ease of doing business when the budget will be presented in parliament on 01st Feb 2020.

Indian economy is slowing down. India's unemployment rate increased to 7.7 per cent in December 2019. GDP growth has slipped below 5 per cent in the last two quarters as weak demand and slump in investment continue to weigh on the country's economic growth momentum. There are many reasons behind slowing Indian economy. At this juncture, start-ups are coming as a saviour to economic slowdown. As per the data presented by Shri Piyush Goyal, Minister of Commerce & Industry, 2,85,890 jobs are reported by 23,657 DPIIT recognized start-ups, as on 4 December 2019.

Undoubtedly, there is constant display of the Government's effort to facilitate growth of start-ups as many issues faced by start-ups were addresses by Govt. in previous budgets. However, there is still a lot to be done to boost Government of India's start-up India flagship. Here, we have noted various issues in Income Tax which Finance Minister should address in the coming Budget to build a strong start-up ecosystem in India for nurturing innovation and generate employment opportunities.

1. Carry forward of Losses:

In the initial years of operations, start-ups generally test their business viability. There is tendency to offer deep discount to generate revenues. Start-ups start generating revenues but not profits, due to which, they end up mounting huge losses.

At present, business loss can be carried forward for 8 Assessment Years immediately following the year for which the loss was first computed. It is not possible to define an average time to make start-up profitable because different start-ups will measure profitability in different ways.

The issue with current policy is that most start-ups have front loaded expenses and will not have profits to offset against it for several years. Hence, this limit of 8 years should be done away with in case of start-ups. Eligible start-ups should be allowed to carry forward such losses indefinitely or such period should be extended based on period of gestation in the particular industry to ensure that operating losses can be set off in full against future profits.

2. Liberalise approach in extending benefit of Section 80-IAC:

Section 80-IAC of the Act was introduced by Finance Act, 2016 to provide for deduction in respect of profits and gains derived by eligible start-up. Post getting clearance for Tax exemption, the Start-up can avail tax holiday for 3 consecutive financial years out of its first 7 years since incorporation under section 80-IAC.

As per data available on start-up India portal, 27011 start-ups have been recognized by DPIIT, out of that only 247 start-ups have been granted exemption under Section 80-IAC of the Income Tax Act. Hence, benefit of Section 80-IAC extended to less than 1% of the start-ups recognised by DPIIT. There is wide difference between the number of start-ups recognised by the DPIIT and the start-ups granted exemption under section 80-IAC of the Income Tax Act.

Start-ups hope for faster policy execution at government front. Hence, the DPIIT should speed up the process and remove glitches to pass on the benefit of Income Tax Exemption on profits under Section 80-IAC of Income Tax Act.

3. Parity in the turnover limit:

The Department of Promotion of Industry and Internal Trade (DPIIT) issued Notification No. GSR 127 (E) [F.NO.5 (4)/2018-SI], dated 19-02-2019, which superseded all previous notifications issued by the DPIIT. In the said notification, the DPIIT has prescribed the conditions for a start-up to claim Section 80-IAC deduction and exemption from angel tax levied under Section 56(2)(viib). Among other conditions, one of the conditions provides that the turnover of the eligible start-up should not exceed Rs. 100 crores in any of the ten financial year since its incorporation.

It has to be noted that start-ups recognised by DPIIT which fulfil the conditions specified in the DPIIT notification did not automatically become eligible for deduction under Section 80-IAC of the Act. A start-up has to fulfil the conditions specified in Section 80-IAC for claiming this deduction. Further, a recognized start-up is required to file Form 1 along with the specified documents to the Inter-Ministerial Board of Certification.

Section 80-IAC provides that for claiming tax holiday, the turnover of eligible start-up should not exceed Rs. 25 crores in the previous year relevant to the assessment year for which deduction under this section is claimed. The provisions of section 80-IAC and notification issued by DPIIT have prescribed different threshold limits, thus, they are in conflict with each other. In case turnover of a company is Rs. 50 crores, despite the fact that it is an eligible start-up as per the DPIIT's notification, it won't be eligible to claim the deduction under Section 80-IAC. Further, CBDT issued press release dated 22-8-2019 stating that the turnover limit for small start-ups claiming deduction is to be determined by the provisions of Section 80-IAC of the Act and not from the DPIIT notification.

Finance minister should consider the fact that the early-stage start-ups focus on their top line growth for scaling up due to which they gain momentum in top line but struggle to achieve bottom line growth or profitability. Hence, the Finance Minister should increase the turnover limit for claiming section 80-IAC benefit in line with the notification issued by DPIIT.

4. Rationalise provisions of Taxation of ESOPs:

ESOPs provide employees with ownership stakes in the company via stocks. Giving ESOPs is a usual trend in start-ups where the companies give option to its employees, in lieu of high salary, to save high cash outflows, as the resources are limited in the initial phase. This helps start-ups to retain Employees even when paying lower salaries.

ESOP's are taxable at 2 stages:

4.1 Taxable as Salary:

Employees get taxed when they exercise their options and convert their ESOP to shares. When employer allots shares to an employee under ESOP scheme, free of cost or at concessional rate, it is taxable as perquisite in the hands of Employee. The value of such perquisite shall be its market value as on the specified date as reduced by the amount recovered from employee.

4.2 Taxable as Capital Gains:

When shares allotted under ESOPs are sold, the gains arising therefrom shall be taxable under the head Capital Gains. To calculate the capital gains, the market value of shares on the date of exercise of option shall be deemed to be its cost of acquisition.

In case of start-ups, ESOP should only be taxable at the time of actual sale of shares by employee. There are few arguments why this amendment should be brought in.

First issue is taxability at the time of allotment of shares causes genuine hardships since the gain arising at the time of allotment of shares is notional gain on the basis of valuation. Further, in case of start-ups, valuations change drastically over a period of time.

Second issue is that there is usually no market where shares of start-ups can be sold. Employees of start-ups get exit only when there is new investor coming in or start-up gets acquired.

Since there is no actual cash gain in the hands of employee at the time of allotment of shares, Finance minister should consider this long pending demand of Tax deferrals to the point of sale rather than the point of vesting for employees in case of ESOP's allotment by start-ups.