Startup

Tax exemptions for start-ups and other incentives

A start-up, in the broadest sense, is a business venture launched by entrepreneurs, often young and inexperienced, who have new ideas that have the potential to become a substantial business opportunity. A start-up is a business that focuses on the creation, implementation, or commercialization of innovative goods, processes, or services that are fuelled by technology or intellectual property. Its goal is to generate or add value for consumers or workflow by developing and commercializing a new product, service, or process, or by significantly improving an existing product, service, or process. In this article we shall discuss the tax exemptions for start-ups.

Eligible start-ups

In 2016, Prime Minister Narendra Modi introduced the “Start-up India campaign,” which aims to create a supportive environment for innovation, technology, and entrepreneurship. The start-up scheme was created by the Department of Promotion of Industry and Internal Trade (DPIIT).

The action plan was aimed to promote bank financing for start-ups, as well as streamlining the formation procedure for them and providing benefits and other tax exemptions for start-ups or new businesses. However, all such benefits and exemptions for start-ups shall only be available to them if they fall into the criteria of an eligible start-up.  

The following are the criteria for becoming an eligible start-up:

• An entity that has been incorporated and registered in India for less than ten years.
• In all the prior years, the company’s revenue has never exceeded Rs 100 crore.
• The entity is working on developing, improving, or innovating products, processes, or services that have the potential to create jobs or money; and
• A new entity is created without the need to split up or rebuild an existing business.

A sole proprietorship business, a partnership firm, a limited liability partnership (‘LLP’), or a corporation can all be used to start a business. It must, however, be incorporated as a private limited company (under the Companies Act, 2013), an LLP (under the LLP Act, 2008), or a partnership firm in order to be considered an “Eligible start-up.”

Some of the important registrations required for a start-up are as follows:

• PAN and TAN requirement – A Permanent Account Number is a one-of-a-kind unique number assigned by the Income Tax Department. TDS-related compliances necessitate the use of TAN.
• The GST registration is necessary when a business’s or profession’s revenue reaches the stipulated thresholds of Rs 40 lakh for businesses that sell commodities and Rs 20 lakh for businesses that provide services.
• Registration for professional taxes — Eligible start-ups would be needed to register for professional taxes.
• Shop and Establishment License is also needed by start-ups for the place of work of business.
• If a patent registration could be secured to protect the entity’s patent, that would be ideal.
• Certain businesses (for example, telecommunications and broadcast) require industry-specific regulatory permissions before they may start doing business.
• Where the entity is involved in the import or export of goods/services, Import Export Code (IEC) is necessary.

Income tax exemptions for start-ups

Given below are the tax exemptions for start-ups:

Tax waiver at initial stages

In the first seven years after its incorporation, an eligible start-up (that is formed between April 1, 2016, and April 1, 2021) can deduct 100 percent of its profits for a block of three years. A deduction like this would be possible if you filed an application with DPIIT and met specific criteria.

This plan was open to new businesses that were formed between 1^st April, 2016, and 31^st March, 2021. The eligibility period has been extended until 31^st March, 2022, as announced in Budget 2021. Thus, if the annual turnover of such start-ups does not exceed Rs. 25 crores in any financial year, they will be eligible for a 100 percent tax credit on profits for three years in a row. This will assist new businesses in meeting their working capital needs during their early years of operation.

Angel tax exemption

Domestic corporations are needed to issue their shares at fair market value (FMV), which is determined by the merchant banker on the basis of net assets value or discounted cash flow. Any amount received by the company from Indian residents in excess of FMV is subject to tax in the hands of the company (commonly referred to as ‘Angel tax‘). Eligible start-ups are exempt from Angel tax if they file the necessary declaration with DPIIT and meet certain conditions.

In other words, the government has waived the tax on investments in eligible start-ups that exceed the fair market value. Such investments include those made by local angel investors, family members, or funds that are not registered as venture capital funds. In addition, investments made by incubators that exceed fair market value are exempt.

Exemption on set off and carry forward of losses

Business losses can be carried forward and set off under income tax regulations. However, set-off for a private corporation is refused if the shareholding arrangement of the company has changed by 50% or more after the year of the said loss. But eligible start-ups are not affected by this criterion to some extent. This criterion does not apply to losses incurred in the first seven years of an eligible start-up provided that the shareholders who had shares in the year of loss continue to hold shares in the year of set-off.

Section 54EE exemptions for start-ups

A new section 54EE of the Income Tax Act has been added to allow qualifying start-ups to avoid paying their taxes on long-term capital gains if the gain, or a portion of it, is invested in a fund authorized by the Central Government. However, there is a condition that the investment has to be made within six months of the asset being transferred.

In the long-term defined asset, the maximum amount that can be invested is Rs 50 lakhs. For a lock-in period of three years, this sum must be kept invested in the designated fund. But if money is withdrawn before three years, then the exemption is revoked in the year in which the money is withdrawn.

An exemption from LTCG to investors of eligible start-ups

When the net consideration is invested in the equity shares of eligible start-ups, any long-term capital gain on the transfer of a residential property arising to an individual/HUF is excluded from tax.

The existing provisions under Section 54GB allow for the exemption from taxation of long-term capital gains on the sale of a residential property if such gains or proceeds are invested in small or medium enterprises as outlined by the Micro, Small, and Medium Enterprises Act, 2006. However, this provision has been updated to include an exemption for capital gains that are invested in eligible start-ups as well.

Therefore, where an individual or a HUF transfers a residential property and invests the proceeds or its capital gains to subscribe to 50% or more equity shares in qualified start-ups, in that case, the long-term capital gains tax will be exempt if the shares are not sold or transferred within 5 years of their acquisition.

Start-ups must also utilize/employ the funds to purchase assets, and such assets purchased must not be transferred within five years of the date of acquisition. This exemption will encourage the investors to participate in eligible start-ups, allowing them to grow and expand.

Exemption in taxation of ESOP for employees of start-ups

When a qualifying start-up issues ESOPs to its employees (on or after April 1, 2020), the start-up is allowed to deduct tax on those ESOPs with certain exceptions or relaxations.

Some other exemptions for start-ups

Apart from the above, there are a few more benefits or exemptions for start-ups which are outlined below:

• Easy process for the registration of start-ups
• Simple accessibility to funds through Alternate Investment Funds and eligibility to raise ECBs under the relaxed norms
• Eligibility for fast-track patent applications with a benefit of up to 80% rebate in the filing of patents
• Self-certification of compliance under 3 Environmental laws and 6 Labour Laws
• Relaxation from the requirement of earnest money deposit, the requirement of prior turnover, and other experience requirements in case of government tenders
• Ease of winding up of a corporation within 90 days under the regulations of Insolvency & Bankruptcy Code, 2016^[1].

Conclusion

The Indian government has unveiled the ‘Start-up India’ initiative, which aims to create a favourable environment for start-ups in the country. A number of programs have been specifically launched by various ministries of the Indian government for this goal. The government has established a number of incentives for new businesses, and these benefits are increasing year after year.

Read our article:Availing of Notable Taxation & Other Benefits for Start-ups