Budget 2016- Tax Incentives for Start-ups

Manish Agarwal

In his last Independence Day address, Prime Minister Mr. Narendra Modi (“PM”), had announced the ‘Start-up India, Standup India’ initiative. Further, on January 16, 2016, PM had launched the ‘Start-Up movement’ by unveiling the action plan to boost the start-up culture and encourage entrepreneurship in India. Apart from measures like simplification of registration process, low-cost patent registration, compliance regime based on self certification, setting up of Rs. 10,000 crores start-up fund, setting up of research parks, faster exit norms, relaxed norms of public procurement for start-ups, launch of Atal innovation mission etc., PM’s action plan also included tax exemptions to start-ups in the form of exemption from income-tax and capital gain taxation.

In line with PM’s action plan, Finance Minister, in his budget speech, has proposed many incentives to encourage entrepreneurship in India. Some of the tax measures which will be beneficial for new start-ups are as follows-

1. Optional lower tax rate of 25% for newly setup manufacturing companies
2. Hundred percent deduction of profits for three years (Proposed new Section 80-IAC of the Income-tax Act, 1961):
3. Capital Gain Exemption in respect of LTCG proceeds invested in specified start-up fund (New section 54EE)
4. Capital Gain Exemption in respect of LTCG gains arising out of transfer of residential property invested in the shares of start-up Company (Amendment in Section 54GB)

Provisions in respect of above proposals are summarized below-

1. Optional lower tax rate for newly setup manufacturing companies: In case of newly setup companies engaged solely in the manufacture or production of article or thing, it is proposed that a reduced tax rate of 25% would apply. In order to claim the benefit of reduced rate, following conditions should be satisfied –

♣ Company should be registered on or after 1^st March 2016

♣ It should be engaged in the business of manufacture or production of article or thing

♣ It should not claim any benefit under section 10AA, benefit of accelerated depreciation, benefit of additional depreciation, investment allowance, expenditure on scientific research and any deduction in respect of certain income under Part-C of Chapter-VI-A other than the provisions of section 80JJAA. Further, income is to be computed without set off of any loss carried forward from any earlier assessment year if such loss is attributable to any of such deductions.

♣ For computing income, depreciation is to be determined in a prescribed manner.

2. Hundred percent deduction of profits for three years (Proposed new Section 80-IAC of the Income-tax Act, 1961):

♣ It is proposed to provide a deduction of one hundred percent of the profits and gains derived by an ‘eligible start-up’ from an ‘eligible business’ for three years.

♣ ‘Eligible start-up’ means a company-

• Engaged in a business involving innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property (‘Eligible Business’). Company should hold a certificate of eligible business from the Inter-Ministerial Board of Certification as notified by Central Government.
• Incorporated between 1^st April 2016 and 31^st March 2018
• Turnover of which does not exceed Rs. 25 Crores in any of the years from Financial Year 2016-17 to Financial year 2020-21

♣ The benefit would be available to the start-ups for three consecutive years out of the first five years starting from the year of incorporation.

♣  Conditions for availing such deduction, as proposed in the budget, are as follows:

• It is not formed by splitting up, or the reconstruction, of a business already in existence. (This condition would not apply in case of re-establishment, reconstruction or revival by the assessee of the business of any such undertaking as referred to in section 33B, in the circumstances and within the period specified in that section)
• It is not formed by the transfer to a new business of machinery or plant previously used for any purpose. However, this condition would not be applicable if value of such used plant and machinery does not exceed 20% of total value of plant and Machinery used in the business. Further, this condition would not be applicable to a plant and machinery used outside India by any other person if –

i. It is imported by the assessee in India

ii. It was not used at any time in India before the date of installation by the assessee

iii. Prior to the date of installation, no depreciation was allowed or allowable on it to any person under Income-tax Act, 1961.

♣ Apart from the above conditions, it is also proposed that the provisions of sub-section (5) and sub-sections (7) to (11) of section 80-IA shall also apply to the start-ups for the purpose of allowing deductions under this section, which are summarized below-

• For the purpose of computing quantum of deduction, profits and gains of eligible business is to be computed as if such eligible business is the only source of income for the assessee
• Condition in respect of obtaining audit report in the prescribed form
• Condition with respect to transfer of goods and services between the eligible business and other business carried on by the assessee at market value
• Condition in respect of restriction on claiming the same benefit under other provisions
• Power of the AO to restrict the benefit in case of shifting of profits by any other person to the eligible business
• Power of Central Government to direct that the exemption conferred by this section shall not apply to any class of industrial undertaking or enterprise

3. Capital Gain Exemption in respect of LTCG proceeds invested in specified start-up fund (New section 54EE)

• In order to promote the start-up ecosystem in the country, it is envisaged in ‘start-up India Action Plan’ to establish a Fund of Funds which intends to raise Rs 2500 crores annually for four years to finance the start-ups.
• It is proposed to provide exemption from capital gains tax if the long term capital gains proceeds are invested by an assessee in units of such specified fund, as may be notified by the Central Government in this behalf, subject to the condition that the amount remains invested for three years failing which the exemption shall be withdrawn. The investment in the units of the specified fund shall be allowed up to Rs. 50 lakh.

4. Capital Gain Exemption in respect of LTCG gains arising out of transfer of residential property invested in the shares of start-up Company (Amendment in Section 54GB)

♣ It is proposed that long term capital gains arising on account of transfer of a residential property shall not be charged to tax if such capital gains are invested in subscription of shares of a company which qualifies to be an eligible start-up subject to the condition that

• the individual or HUF holds more than fifty per cent shares of the company
• Such company utilises the amount invested in shares to purchase new asset before due date of filing of return by the investor.

♣ Further, it is proposed that the expression “new asset” would now also include computers or computer software in case of technology driven start-ups so certified by the Inter-Ministerial Board of Certification notified by the Central Government in the official Gazette.

Apart from the above beneficial provisions under income-tax Act, beneficial provision in respect of payment of service tax on quarterly basis and facility of payment of service tax on receipt basis is being extended to a One Person Company (‘OPC’) with effect from 1 April, 2016, which would also benefit start-ups registered as OPCs.

It is expected that the above tax benefits would help in boosting Entrepreneurship and Start-up culture in India. These incentives will add to the measures undertaken by PM for ‘ease of doing business in India’ and help ‘Make-in India’ campaign succeed.