Proposed Tax Exemption to Startups in India
Startup India is a flagship initiative of the Government of India, intended to build a strong eco-system for nurturing innovation and Startups in the country that will drive sustainable economic growth and generate large scale employment opportunities. The Government through this initiative aims to empower Startups to grow through innovation and design.
In order to meet the objectives of the initiative, Government of India is announcing this Action Plan that addresses all aspects of the Startup ecosystem. With this Action Plan the Government hopes to accelerate spreading of the Startup movement:
From digital/ technology sector to a wide array of sectors including agriculture, manufacturing, social sector, healthcare, education, etc.; and
From existing tier 1 cities to tier 2 and tier 3 citites including semi-urban and rural areas. The Action Plan is divided across the following areas:
Simplification and Handholding
Funding Support and Incentives
Industry-Academia Partnership and Incubation
The definition of a Startup (only for the purpose of Government schemes) has been detailed below :-
Part A: Definition of Startup (only for the purpose of Government schemes)
Startup means an entity, incorporated or registered in India not prior to five years, with annual turnover not exceeding INR 25 crore in any preceding financial year, working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
Provided that such entity is not formed by splitting up, or reconstruction, of a business already in existence.
Provided also that an entity shall cease to be a Startup if its turnover for the previous financial years has exceeded INR 25 crore or it has completed 5 years from the date of incorporation/ registration.
Provided further that a Startup shall be eligible for tax benefits only after it has obtained certification from the Inter-Ministerial Board, setup for such purpose.
Part B: Definition of terms
Entity Private Limited Company (under The Companies Act, 2013) or a Registered Partnership Firm (under The Indian Partnership Act, 1932) or Limited Liability Partnership (under The Limited Liability Partnership Act, 2008)
covered under the
definition in Part
A business is covered under the definition if it aims to develop and commercialize
a new product or service or process; or
a significantly improved existing product or service or process, that will create or add value for customers or workflow.
The mere act of developing
products or services or processes which do not have potential for commercialization; or
undifferentiated products or services or processes; or
products or services or processes with no or limited incremental value for customers or workflow
would not be covered under this definition.
In order for a “Startup” to be considered eligible, the Startup should
be supported by a recommendation (with regard to innovative nature of business), in a format specified by DIPP, from an Incubator established in a post-graduate college in India; or
be supported by an incubator which is funded (in relation to the project) from GoI as part of any specified scheme to promote innovation; or
be supported by a recommendation (with regard to innovative nature of business), in a format specified by DIPP, from an Incubator recognized by GoI; or
be funded by an Incubation Fund/Angel Fund/ Private Equity Fund/Accelerator/Angel Network duly registered with SEBI* that endorses innovative nature of the business; or
be funded by GoI as part of any specified scheme to promote innovation; or
have a patent granted by the Indian Patent and Trademark Office
in areas affiliated with the nature of business being promoted.
* DIPP may publish a ‘negative’ list of funds which are not eligible for this initiative.
Turnover As defined under The Companies Act, 2013
Inter-Ministerial Board An Inter-Ministerial Board setup by DIPP to validate the innovative nature of the business for granting tax related benefits
Approval from the Inter-Ministerial Board shall not in any manner, limit or absolve the entity(ies) from any liability incurred in case of any misrepresentation/ fraud arising from submission of such application and/ or supporting such application.
Tax Exemption on Capital Gains
To promote investments into Startups by mobilizing the capital gains arising from sale of capital assets
Due to their high risk nature, Startups are not able to attract investment in their initial stage. It is therefore important that suitable incentives are provided to investors for investing in the Startup ecosystem. With this objective, exemption shall be given to persons who have capital gains during the year, if they have invested such capital gains in the Fund of Funds recognized by the Government.
This will augment the funds available to various VCs/AIFs for investment in Startups.
In addition, existing capital gain tax exemption for investment in newly formed manufacturing MSMEs by individuals shall be extended to all Startups. Currently, such an entity needs to purchase “new assests” with the capital gain received to avail such an exemption. Investment in ‘computer or computer software’ (as used in core business activity) shall also be considered as purchase of ‘new assets’ in order to promote technology driven Startups.
Tax Exemption to Startups for 3 years
To promote the growth of Startups and address working capital requirements
Innovation is the essence of every Startup. Young minds kindle new ideas every day to think beyond conventional strategies of the existing corporate world.
During the initial years, budding entrepreneurs struggle to evaluate the feasibility of their business idea. Significant capital investment is made in embracing ever-changing technology, fighting rising competition and navigating through the unique challenges arising from their venture. Also, there are limited alternative sources of finance available to the small and growing entrepreneurs, leading to constrained cash funds.
With a view to stimulate the development of Startups in India and provide them a competitive platform, it is imperative that the profits of Startup initiatives are exempted from income-tax for a period of 3 years. This fiscal exemption shall facilitate growth of business and meet the working capital requirements during the initial years of operations. The exemption shall be available subject to non-distribution of dividend by the Startup.
Tax Exemption on Investments above Fair Market Value
To encourage seed-capital investment in Startups
Under The Income Tax Act, 1961, where a Startup (company) receives any consideration for issue of shares which exceeds the Fair Market Value (FMV) of such shares, such excess consideration is taxable in the hands of recipient as Income from Other Sources.
In the context of Startups, where the idea is at a conceptualization or development stage, it is often difficult to determine the FMV of such shares. In majority of the cases, FMV is also significantly lower than the value at which the capital investment is made. This results into the tax being levied under section 56(2) (viib).
Currently, investment by venture capital funds in Startups is exempted from operations of this provision. The same shall be extended to investment made by incubators in the Startups.