Startup Taxation – A Reality Check
- Blog|Income Tax|
- 658 Views
- 6 Min Read
- By Taxmann
- Last Updated on 10 May, 2021
Are you a Startup?
- Not more than seven years have elapsed from its incorporation/ registration (for an entity in the biotechnology sector, this period is 10 years).
- The turnover of the entity in any financial year since incorporation/ registration has not exceeded INR 250 million.
- The entity is working towards innovation, development or improvement of products or processes or services, or is a scalable business model with a high potential of employment generation or wealth creation.
Tax benefits – Soft Corner for Startups:
1. Tax Holiday for three consecutive years:
2. Capital gains tax exemption:
To boost the startup ecosystem in India, a long-term capital gains exemption up to INR 5 million is provided, if the amount equal to capital gain arising from the sale of capital assets is reinvested in the units of a notified fund set up for Startups for a period of at least three years.
3. Carry forward of losses despite the substantial change in ownership:
The Indian tax regime allows the protection of unabsorbed tax losses of Startups incurred in the initial seven years of its operations, as long as all the shareholders in the year of incurrence of loss continue to be shareholders in the Startup company in the year of carry-forward and set-off. Therefore, such protection is available even if the change in shareholding is beyond 49% threshold applicable in other cases.
4. No Angel tax:
In another welcome move by government authorities towards encouraging Startups in India, eligible Startups have been excluded from the ambit of angel or premium taxation under section 56(2)(viib) of the Income-tax Act, 1961. Therefore, where a Startup issues its shares to any angel investor in consideration of funding received from the investors at a price exceeding the fair market value of the shares of the Startup, any excess over the fair market value (i.e. premium) is not taxed in the hands of the Startup post this amendment.
A reality check – Are the incentives for real or just eyewash?
While the incentives provided by the government to encourage entrepreneurship in India through Startups seems to have made the journey easier and thought-provoking for ignited young minds; however, it is still not a cakewalk. These incentives are available to specific eligible Startups and are subject to fulfilment of certain conditions. Some of the issues in claim of such benefits are enumerated below:
1. Subjectivity on “Innovation”:
How one defines and understands innovation may differ owing to different perspectives. This scope of subjectivity may deprive an entity of recognition as an eligible Startup. Per the guidelines, any entity that wishes to be recognised as an eligible Startup for tax and other benefits has to apply to the regulatory authority with a write up about the nature of its business, highlighting how it will help in fostering innovation, development or improvement of products and services. It is always a possibility that the regulator may have a different view and may reject such claim.
2. There “is” a tax deduction, but there “are” conditions:
The golden incentive of 100% deduction of profits for tax purposes seems good; however, it comes with a set of conditions, some of which are as follows:
- The exemption is only available to Startups that are private companies or LLP formed on or after 01 April 2016;
- It holds a certificate of eligible business from the Inter-Ministerial Board of Certification;
- Startups are not formed by split up or reconstruction of an existing business;
- Plant and machinery used in the business should be new and have never been used in India before;
- The total turnover of the Startup is not exceeding INR 250 million in the relevant financial year.
3. Angels fly a “little” high:
While the government recently exempted eligible Startups from taxation on premium received over and above the fair market value of their shares on its issue to eligible investors, a closer look may reveal this to be eyewash, as the horizon of such exemption is very limited. A Startup shall be eligible to claim such exemption only if the following conditions are fulfilled:
- Startup being a private limited company;
- The sum total of “paid-up capital and share premium” of the Startup after issue of shares to eligible investor does not exceed INR 100 million;
- A valuation report has been obtained from the Merchant Banker specifying the fair market value of shares;
- The investor has an average returned income of at least INR 2.5 million in the last three years or has a net worth of at least INR 20 million on the last day of the preceding financial year.
4. Investor exits, loss lapses:
Authors: Hiten Kotak, Leader – M&A Tax, PwC India and Amit Bahl, Partner – M&A Tax, PwC India
Disclaimer: Views are personal to the author. The article includes inputs from Nikhil Goenka, Director – M&A Tax, PwC India, and Shubham Aggarwal, Associate – M&A Tax, PwC India.
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