Backdrop to the Start-ups in India
In January 2016, the Modi Government launched its flagship initiative “Startup India” with a vision to build a strong ecosystem for encouraging entrepreneurship in India and nurturing innovation. It was a step to facilitate sustainable economic growth, generate larger employment opportunities, promote foreign investment and enable ease of doing business for the start-ups in India.
The government thereby also launched Startup India Action Plan, focusing on the three pillars- (i) Simplification and Handholding, (ii) Funding Support and incentives, and (iii) Industry-Academia Partnership and Incubation.
By virtue of the above Startup India Action Plan, eligible start-ups in India can avail various regulatory and tax benefits / incentives and can also have access to funding options, subject to fulfilment of certain conditions / criteria.
Listed below are few tax benefits available even prior to the introduction of Budget 2020-
(i) Eligible start-ups formed on or after 1 April 2016 (but before 1 April 2021) and with a turnover not exceeding INR 25 crores can claim 100 percent of deduction of the profits earned for any 3 consecutive years out of first 7 years from the date of incorporation;
(ii) Capital Gain exemption has been provided in respect of long-term capital gains upto INR 50 lakhs, if the capital gains is reinvested in the units of a notified fund set up for start-ups for a period of atleast 3 years;
(iii) Eligible start-ups have been exempted from angel tax [premium taxable under section 56(2)(viib) of the Income-tax Act, 1961 (‘the Act’)];
(iv) Carry forward of loss to be allowed even if there is a change in shareholding beyond 49 percent threshold as prescribed under section 79 of the Act.
Amendments in relation to the Start-ups as proposed by the Finance Bill, 2020
The Finance Minister in her speech mentioned that the start-ups have emerged as engines of growth for our economy.
However, as a reality check, while the above tax benefits were available, they were subject to satisfaction of various conditions which made it impracticable for the start-ups to claim the tax benefits. Therefore, rightfully the government has sought to relax the conditions so as to encourage more start-ups in India and also to pass on the realistic tax benefits to the eligible start-ups. The proposed amendments are discussed below-
• Relaxation of conditions for claiming tax holiday under section 80-IAC
While tax holiday is available to the start-ups for 3 consecutive years out of first 7 years, considering the fact that in many cases, the gestation period for a startup to break-even may be longer, it was practically not possible for them to claim the benefit of the tax holiday. With this hurdle in mind, it has now been proposed to extend this period of 7 years to 10 years.
Therefore, now an eligible startup can claim the tax holiday of 3 consecutive years out of the 10 years from the year of incorporation.
Further, the turnover limit for eligible start up has also been increased from the existing INR 25 crores to INR 100 crores.
• Taxability of Employee Stock Option Plan (‘ESOP’)
It is a general practice in the start-ups that during the formative years, they use ESOPs to attract and retain highly talented employees at a relatively low salary amount with the balance being made up by ESOPs.
Currently, the ESOPs are taxed as perquisites at the time of exercise of option. The tax on such perquisite is required to be paid at the time of exercising of option which lead to cash flow problem since there is no cash inflow in the hands of the employee at the time of exercise of option.
In order to ease the above burden of payment of tax by the employees of start-ups or TDS by the startup employer, it is now proposed to insert subsection (1C) in section 192 which defers the tax liability on on ESOPs and sweat equity shares.
As per the proposed amendment, the tax deduction or payment as the case may be on such ESOPs shall be within fourteen days from the earliest of following on the basis of the rates in force of the financial year in which the specified security or sweat equity share is allotted or transferred:
• after the expiry of forty-eight months from the end of the relevant assessment year (i.e. 5 years from the financial in which the specified security or sweat equity share is allotted or transferred to the employee); or
• from the date of the sale of such specified security or sweat equity share by the assessee; or
• from the date of the assessee ceasing to be employee of the eligible startup.
The above amendments are a welcome move in order to give much desired boost to the eligible start-ups. While the amendment to section 80-IAC will widen the number of eligible start-ups for claiming the deduction / tax holiday under the said section, deferment of ESOP taxability will also provide liquidity for the start-ups and its employees.
Having said the above, while deferment of ESOP taxability is a welcome step, restricting it to the employees of startup will not be appropriate as the employees of companies (other than start-ups) also are on the same footing as they also do not receive any cash flow at the time of exercise of option. Therefore, the above proposed ESOP taxability should be the same for all the employees irrespective of whether they are employees of start-ups or otherwise.
Some other benefits / announcements for start-ups:
Some of the other steps by the government to boost the economy and to provide the much-needed push to the start-ups.
• The government has proposed to set up seed fund which will provide early life funding, support ideation and development of early stage start-ups.
• In order to expand the base for knowledge-driven enterprises, intellectual property creation and protection will play an important role, several measures are proposed in this regard, which will benefit the Start-ups.
• Investment clearance cell will be set up for providing “end-to-end” facilitation and support, including pre-investment advisory, information advisory, information relating to land banks; and facilitate clearance at centre and state level.
While the above steps and announcements are welcome in order to provide a much needed impetus to the start-ups, only time will tell whether the desired objective is achieved in the sought direction.
Further, introduction of TDS provisions (at the rate of 1 percent) on e-commerce transactions will not only impact the cash flow of the start-ups but also increase the compliance burden on the start-ups in the e-commerce industry, considering the fact that there are many start-ups in the e-commerce space and also with a very thin margin at times.
Also, introduction of TCS provisions on overseas tour packages [at the rate of 5 percent (10 percent in absence of PAN or Aadhaar) and on purchase of goods in excess of INR 50 lakhs (at the rate of 0.1 percent) will increase the compliance burden for start-ups.
The above amendments in the TDS and TCS provisions are no way in the direction of ease of doing business and will result into lot of practical difficulties and challenges for the start-ups to comply with the same. Lets hope the government acts as a stimuli and not a roadblock of compliances for the growth of the start-ups.
1. The author acknowledges the support provided by CA Rishabh Parekh for this article