The start-up, as an idea, has now inspired many across the world. It has strengthened various economies, built entrepreneurship skills, created enormous job opportunities along with wealth and has spread its roots in India. The factors that have led to this surge in India are availability of funding, technological breakthroughs, artificial intelligence and an increased demand due to higher purchasing power.

A start-up, as defined by the Indian tax law, is a business:

  • Within its initial seven years of incorporation (10 years for biotechnology start-ups)
  • Not exceeding a turnover of INR 250 million in any 7/10 years;
  • Works towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with high potential of employment generation or wealth creation;
  • Not formed by splitting up or reconstruction of a business already in existence;
  • Has obtained certification from the Inter-Ministerial Board setup for such a purpose; and
  • Can be incorporated as a private limited company, registered partnership firm or a limited liability partnership.

To be recognised, these start-ups must apply to the Department of Industrial Policy and Promotion (DIPP), which at its discretion may accept or reject the application.

Although there are some good tax incentives to boost investments in start-ups, such as income tax exemption for capital gains on sale of long term capital asset/ residential house/ residential plot of land if investment is made in units of specified funds investing in startups/ eligible startups; however, there is still a lot to be done.

Tax holiday has been provided for profits and gains derived by an eligible start-up for three years, in a block of the first seven years. However, as observed, startups are rarely profitable in their initial years and even if they break even early, the profits are subject to Minimum Alternate Tax (MAT). Further, an entity ceases to be a start-up on completing seven years from the date of its incorporation or if its turnover exceeds INR 250 million in any year. Hence, many businesses are unable to reap the benefits of this tax holiday.

As per a recent notification by the CBDT, a start-up with paid-up capital including premium up to INR 10 crores can raise capital at issue price being more than the fair market value of such shares, without attracting the provisions of income-tax law. In today’s business environment, raising INR 10 crores in capital is not a big ask. Therefore, this relief somehow limits a business from attracting more capital. Further, this benefit is also available on a case-to-case basis and not to every start-up.

The carry forward of losses for eligible start-ups is allowed if all shareholders of such company who held shares carrying voting power on the last day of the year in which the loss was incurred continue to hold shares on the last day of year in which such loss is to be carried forward. This provision comes as a hardship for many startups, as it is even more onerous than the previous section, which gives leeway for change in shareholding up to 49%. In today’s era, where there is continuous entry and exit of investors in startups that is beyond the control of founder, the benefit is lost.

As seen nowadays, various start-ups issue Employee Stock Option Plans (ESOPs) by setting up an ESOP trust, as an incentive to their existing workforce, encouraging them to work harder and grow with the business. Such ESOPs are granted to employees at the end of the vesting period, wherein the employees pay a nominal exercise price, which is generally lower than its actual fair market value, and participate in the equity capital of the company. The said perquisite is taxable in the hands of the employees as salary. The current tax law is causing hardship where not only is the employee taxed but the trust is also susceptible to tax, as capital gains as such shares are granted to employees at a consideration lower than the fair value of the shares. This results in taxing of ESOPs at an effective rate of ~58%.

With the increase in valuation and global operations of any start-up, the options of listing shares overseas become lucrative as huge volumes of funds can be raised in global markets. A welcome move for entrepreneurs would be allowing the listing of Indian companies on overseas stock exchanges.


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Author: Annu Gupta, Partner – M&A Tax, PwC India

The views expressed in this article are personal. This article includes inputs by  Neerja Mohta – Manager, M&A Tax, PwC India, Nikita Yadav – Associate – M&A Tax, PwC India.

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September 2021