Tax Illusion: Unraveling the Reality of Startup Deductions

Introduction: In the dynamic landscape of the Indian economy, the term “startup” resonates with innovation, entrepreneurship, and economic growth. With the booming success of numerous startups evolving into unicorns, the allure of establishing one’s own startup has captured the attention of both the common man and policymakers. To foster this spirit, the Indian Government launched the Startup India Initiative on January 16, 2016, aiming to nurture a thriving ecosystem for startups.

Start-up India Initiative

The Start-up India Initiative, which was launched on January 16, 2016, is focused on promoting entrepreneurship and supporting the growth of start-ups in India. To achieve this goal, the initiative has implemented several programs to build a strong and supportive ecosystem for start-ups. A dedicated team manages these programs within the Department of Promotion of Industry and Internal Trade (DPIIT), which oversees the initiative’s operations and progress. The start-up India Initiative aims to transform India into a country where entrepreneurs and start-ups thrive, creating new jobs and contributing to the country’s economic growth.

What is DPIIT?

DPIIT is the Department of Promotion of Industry and Internal Trade. DPIIT is a Central Government department under the Ministry of Commerce and Industry. It has been constituted to promote internal trade, including retail trade, the welfare of traders and their employees, and matters relating to facilitating ease of doing business. Additionally, policies for the promotion and benefit of Start-ups are also dealt with by the DPIIT.

Why shoulda Start-up be recognized by DPIIT?

Certain benefits flow to an entity if it is an ‘Eligible Start-up’, and to become an eligible Start-up an entity has to satisfy various conditions prescribed under Notification No. GSR 127(E), Dated 19-2-2019,issued by the DPIIT. Although there are additional conditions to claim certain benefits or relief under the Income-tax Act, but recognition by the DPIIT is mandatory for claiming such benefits.

Income Tax Act also prescribes various tax exemption to startup and investor of startup.

Tax Benefit to Startup/Investors:

The following benefits shall be available to an eligible start-up recognized by the DPIIT:

(a) Exemption to the company from levy of angel tax under Section 56(2)(viib)

(b) Deductions under Section 80-IAC to the start-up

(c) Liberalised regime of Section 79 to carry forward and set off the losses of start-up

(d) Deduction u/s 54GB on transfer of residential property invested in eligible startup.

The list of different forms of entities eligible for benefits under various sections of Income Tax which is recognized with DPIIT is as under:

Analysis of Section 80IAC under Income Tax Act:

In above benefits, Tax Holiday for 3 years are most important provision under the income Tax Act. Tax Holiday u/s 80IAC is available with a certain terms and conditions. A brief analysis of Tax holiday entrusted in the Income Tax Act is as under:

1. It is available to a company or LLP incorporated after 1^st Day of April 2016 but before 31^st March 2024. The Company or LLP should be engaged in the business of innovation, development or improvement of products or process or services or a scalable business model with a high potential of employment generation or wealth creation.

2. Total turnover of its business should not exceed Rs 100 Crore in the previous year relevant to the assessment year for which tax holiday is being claimed.

3. The Company or LLP should have certificate of eligible business startup from DPIT.

4. Startup should not be formed by splitting up, reconstruction of business already in existence but any startup which has been reestablished, reconstructed or revival of any undertaking due to extensive damage due to Flood, Hurricane. Earthquake, riot, civil disturbance, accidental fire or explosion etc within a period of 3 years from the end of the previous year in which such incident happens shall not be considered as reconstruction of business already in existence.

5. Value of old Plant & Machineries previously used in India should not exceeds 20% of total value of Plant & machineries used in the business.

6. Startup can avail 100% tax holiday for any consecutive 3 years out of 10 years from the date of incorporation. This means that even a eligible startup can avail 100% tax holiday in last 3 years also if it is beneficial to them.

7. If any company had various units or division one unit or division is eligible startup than while computing the quantum of profit, It is considered that the eligible start up is only source of Income.

8. To claim the benefit, Accounts of start up should be audited by a chartered accountant before specified date and the audit report should be furnished on or before the specified date i.e. one month before the due date of furnishing return u/s 139(1).

9. If Profit of the eligible startup is higher compared to normal profit due to close connection between the parties than assessing officer may take the deemed reasonable profit.

10. If deduction is allowed under this section than no other deduction is allowed than no other deduction shall be allowed for amount already claimed as deduction under the chapter head “ Deduction under the head Certain Income.”

11. To claim benefit u/s 80IAC, Startup has to register itself onto :Startup India Portal” along with following documents:

An application for exemption can be made using the following details:

1. Memorandum of Association in case of a Private limited company or a LLP deed in case of a limited liability partnership

2. Board resolution.

3. Balance sheet and profit and loss account of the entity for the immediately preceding 3 financial years (the financial statements should be certified by a Chartered Accountant

4. Income tax returns of the entity for the immediately preceding 3 financial years.

5. Start-up video link and pitch deck

Is exemption illusory? :

Tax holiday seems to be illusory for private company or LLP start-up if MAT under section 115JB or 115JC applies – Section 115JB or JC of the Act provides that if 15% on book profits of a company is more than tax on total income, book profits shall be total income and 15% of book profits shall be the minimum alternate tax payable. There is no exemption from MAT for start-up companies as no amendment has been made to section 115JB or 115JC exempting profits of a start-up from MAT or AMT.

Though one section May claim that 115JB is not applicable if deduction is claimed under the heading -C- Deduction in respect of certain income as the same was held in the case of In Neha Home Builders (P.) Ltd. v. CIT [2018] 92 taxmann.com102 (Mumbai – Trib.), in the context of deduction under section 80-IB(10), that in section 115JC the legislature clearly mentions that ‘deduction claimed’ if any, under the heading ‘C.-Deductions in respect of certain incomes’ will be added to total income for determining Adjusted Total income for AMT(Alternate Minimum Tax) for non-corporate assessees. Since section 115JB dealing with MAT for companies does not contain any such provision like section 115JC, Chapter VIA-Part C deductions will have to be allowed for computing book profit for MAT purposes. If the legislature’s intention was not give benefit of section 8O-IB(10) for the purpose of MAT calculation, then legislature would have provided same type of provision in section 115JB which is currently absent. This shows that legislature wants to give benefit of deduction under section 80-IB(10) for the purpose of section 115JB calculation but as per my humble view the same is incorrect as section 115JB start with the word Profit as per statement of Profit & Loss account in increased by certain amount. Since Profit as per statement of Profit & Loss account inter alia includes deduction claimed amount u/s 80IAC hence it is automatically covered u/s 115JB and startup has to pay MAT or AMT hence tax exemption u/s 80IAC seems to be illusory.

Whether Opting of Section 115BAB is beneficial compared to 80IAC:

Section 115BAB prescribes lower tax regime i.e. 17.16% for certain new manufacturing companies. Companies who have opted for 115BAB is not required to pay MAT u/s 115JB. This means that company must pay 17.16% through out the life of the company whereas if eligible start up engaged in manufacturing is opting 80IAC than it has to pay minimum Alternate tax @ 18.5% for 3 years even though it has availed the complete tax holiday u/s 80IAC though it can claim tax credit u/s 115JAA in subsequent year but provided tax payable exceeds MAT.

Conclusion: From the above discussion, It seems that if startup is engaged in the manufacturing and if does not intend to take benefit of angel taxation u/s 56(2)(x) than provision of section 115BAB is better than 80IAC. If start up is not engaged in the manufacturing than start up has to take decision considering all situation and probable profitability. It is not the situation that formation of private limited companies is always beneficial though it is advisable if want to raise money from outside.