Eligibility, Tax exemptions & Incentives to Startup

Background:

Prime Minister Mr. Narendra Modi proclaimed the “Startup India campaign” in January 16, 2016 to boost entrepreneurship in India. The action plan aimed to build strong eco-system for nurturing innovation and startups in the country that will drive sustainable economic growth and generate large scale employment opportunities.

In order to meet the objectives of the initiative, the Government of India promote bank financing for startups, simplifying the incorporation of startup process and grant of various tax exemptions and other benefits to startups.

Under the Startup India Action Plan, startups that meet the definition as prescribed under G.S.R notification 127(E) are eligible to apply for recognition under the program. If the startup falls under the criteria of “Eligible Startup” then it will be eligible to avail exemptions and benefits as mentioned in above notification.

So in this article we will discuss whether your entity is “Eligible Startup” and if yes what are the exemptions and benefits available?

Definition of Eligible Start-ups:

An entity shall be considered as Startup;

• Upto a period of 10 years from the date of its incorporation / registration, if it is incorporated as a private limited company (as defined in Companies Act, 2013) or registered as a Partnership Firm (registered under Section 59 of the Partnership Act 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
• Turnover of the entity for any of the financial years since incorporation / registration does not exceed Rs. 100 crore.
• It should be working towards innovation, development or improvement of product or process or services or if it is a scalable business model with high potential of employment generation or wealth creation.
• The entity should not be formed by splitting up or reconstruction of an existing business

Application Process:

• The startup shall make an online application to Department for promotion of Industry and Internal Trade (“DPIIT”) over the mobile app or portal setup by DPIIT.
• Application shall be accompanied by following documents:

a) Certificate of incorporation / registration, as the case may be, and

b) A write-up about 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 DPIIT may, after calling for such documents and information and making such enquiries, as it may deem fit either recognize the eligible entity as a startup or reject the application by providing reason.

As on 01.03.2020, total 28,979 startups have been recognized by the DPIIT as “Eligible startups”. Maximum numbers of startups are recognized from Maharashtra, Karnataka, Delhi, Uttar Pradesh, Haryana, Telangana, Gujarat and Tamilnadu. These startups are allowed to enjoy certain tax and non-tax benefits under the startup India Programme.

Benefits under Income tax Act, 1961 for Startups:

Once your startup is recognized by DPIIT, you may avail the following benefits under Income tax Act.

a) Deduction u/s 80-IAC of Act: To promote growth of startups and address working capital requirements, an eligible startup can avail deduction of 100% of profits for any 3 consecutive years out of 7 years from the date of its incorporation. Further, it has to fulfill the following conditions to claim this deduction:

• It is incorporated as a company (Private Ltd. Co. or Public Ltd. Co.) or an LLP.
• It is incorporated on or after April 1, 2016 but before April 1, 2021.
• Its turnover does not exceed Rs. 25 crore in any Financial Year for which deduction is claimed.
• It is not formed by splitting up or reconstruction of a business already in existence.
• It is not formed by transfer to a new business of machinery or plant previously used for any purpose.
• It holds a certificate of eligible business from the Inter-Ministerial Board of Certification.
• It is engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation.

b) Tax exemptions on investments above fair market value: Section 56(2) (viib) requires a company (issuer), not being a company in which public are substantially interested, to issue shares at a fair market value (FMV). Any consideration received by such company in excess of FMV then such excess being liable to tax as an income from other sources. It is popularly known as “Angel Tax”.

To claim the above exemption, the startup has to file declaration in specified form i.e Form 2 with DPIIT along with required details. Exemption from levy of angel tax under section 56(2)(viib) is available subject to fulfillment of certain conditions. Kindly refer the notification G.S.R. 127(E) dated 19.02.2019 for more details.

c) Relaxed provisions for set-off and carry forward of losses: Section 79 deals with the provisions for set off and carry forward of losses in case of companies. It is stipulated that in case of a company, not being a company in which the public are substantially interested, shall not be allowed to carry forward and set-off the losses against the income of previous year, unless on the last day of the previous year, the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.

The above condition is relaxed for an eligible startup. Hence an eligible startup shall be allowed to carry forward and set-off losses against income of previous year on fulfillment of either of the two conditions specified above;

• Continuity of 51% of shareholding or,
• Continuity of 100% of original shareholders (i.e the restriction of holding of 51 per cent of voting rights to be remaining unchanged u/s 79 has been relaxed in case of eligible startups)

d) Tax exemption to individual/ HUF on investment of long term capital gain in equity shares of eligible startups u/s 54GB: The provisions of Section 54GB of the Income Tax Act exempts the capital gain arising from transfer of a long term capital assets being a ‘residential property’, if the amount of net consideration is invested in small and medium enterprise as defined under the Micro, Small and Medium Enterprises Act. 2006 and eligible startup.

Thus, if an individual or HUF sells a residential property being a long term capital asset and invests the net consideration of capital asset to subscribe the 25% or more of share capital / voting rights of eligible startup, then the following amount of capital gain shall not be charged to tax under section 45 of income tax act.

• If the amount of net consideration is equal to or less than cost of new asset, then the entire amount of capital gain
• If the amount of net consideration is greater than the cost of new asset, then proportionate capital gain would be exempt in following manner:

(Investment in new asset * capital gain) / net consideration

Provided, the equity shares of the company or the new asset acquired by the company are not sold or transferred within five years from the date of its acquisition. This exemption will boost the investment in eligible startup and will promote their growth and expansion.