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With a view to keep accelerating and encouraging entrepreneurs in the start-up space, the government has been introducing various incentives and benefits for eligible start-up businesses. The budget 2017 has proposed changes to the tax legislation which aims to further incentivize the start-up companies. This article aims to provide an insight to some of the significant tax proposals having an impact in the start-up segment.

The existing provisions of the Income tax Act, 1961 (“ITA”) provide start-ups incorporated between 1 April 2016 – to 1 April 2019 to claim 100% deduction of the profit earned, for three consecutive years out of the first five years from incorporation. The government now proposes to increase the block period from five years to seven years, thereby leading the start-up entity to have a longer period to avail the incentive owing to the initial losses usually suffered during the set-up period.

Despite the tax holiday, start-ups shall continue to be subject to Minimum Alternate Tax (“MAT”) provisions in case of book profits which would continue to impact their cash flows. However, availability of MAT credit is proposed to be increased to a period of 15 years vis a vis 10 years per the existing provisions. This shall further aid startups to optimize their tax costs during their profitable state in the future.

Further, post the start-up phase, such companies having a turnover of less than INR 50 crore in the previous year i.e. financial year 2015-16, are proposed to be taxed at a rate of 25% which is lower than the present tax rate of 30% for corporates. However, the availability of aforesaid reduced rate for start-ups which were not incorporated in FY2015-16 is not free from doubt.

Carry forward of tax losses has been an ever-facing challenge for start-ups and a concern for investors planning to invest therein. Having regard to the initial losses and need of funds for growth, it has now been proposed to allow eligible start-ups (start-ups as defined under section 80IAC) to carry forward the tax losses despite of change in shareholding by more than 49%, provided the promoters continue to hold the original stake in the business. Such loss making companies shall be able to carry forward tax business losses despite change in shareholding for a span of seven years.

One of the conditions for an eligible start-up under existing provision of section 80IAC of the ITA refers to an entity which does not have a turnover exceeding INR 25 crore during 1 April 2016 to 31 March 2021 (proposed to now be extend to 31 March 2023). However, there arises an ambiguity as to whether or not the benefit of carry forward of losses or reduction in profits due to set off from such carry forward losses, if availed by an eligible start-up, would be available in a case where the turnover of the start-up exceeds 25 crore in the remaining block period.

There has been considerable debate on the treatment of tax on conversion of preference into equity due to lack of clarity in the existing provisions of the income tax law. A welcome move has been taken by the government by proposing to treat conversion of preference shares into equity to be tax free. The proposal shall aid to provide flexibility to start-ups and investors to structure investments and management rights.

Owing to promote a digital economy, the government has also proposed changes to the presumptive income scheme. Under the proposed scheme, start-ups receiving gross receipts by way of payee cheque, account payee bank draft or by use of electronic clearing system through a bank account would be subject to a 6% tax rate on gross receipts as compared to 8% per the existing provisions. Further, the threshold for conducting an audit for taxpayers under the presumptive taxation scheme is proposed to be increased from INR 1 crore to INR 2 crore. These proposals shall reduce the compliance burden and tax costs for start-ups.

The above legislation proposals aim to provide an environment of ease in doing business for start-ups and also aim to incentivize them for the losses incurred during the initial set up. Considering the growing size of start-ups, the above amendments would also attract investors and promote pumping in funds as required by start-up

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June 2021