Tax Benefits for the Startups and Small Business in India.

In recent years, the Indian Startup ecosystem and Small Business Ecosystem have taken off and are on the verge to get mature. In a young country like India, with a population of around 1.3 billion out of which around 30% are youth between the age of 15-24 years, these startups and small businesses emerged as one of the strong pillars of the Indian Economy.

Driven by factors such as availability of funding, evolving technologies and increasing demands within the domestic markets India emerges as one of the top 5 Startup Ecosystems of the world. Adding to these factors having a Prime Minister like Hon’ble Mr. Narendra Damodardas Modi with a vision to grow India as a Job creator rather than Jobseeker is like a cherry on the top of the cake.

With various favorable policies, initiatives and programs of the Government of India, it becomes really easy to set up and grows self-sustained business models. Initiatives like Startup India, Made in India, etc is definitely helping the Ecosystem grow faster than ever before.

But one of the most important and a matter of concern of every early age Startup is the Taxation Compliance and effects. Startup is something which can be compared with a new small but growing plants which absorbs all the resources but provides the fruit only after a significant time. In the early age of startups, being a new concept need a little time to flourish and be capable of competing in a market and taxing their operation would simply act as a pest to the plant which eventually leads to the destruction of the plant.

As said earlier having a Startup friendly Government is a VARDAAN to the Ecosystem. The government of India along with various initiatives have introduced various Taxation benefits to the Startups and Small Businesses. These benefits are something which is a must-to-know thing for the founders to take the proper benefit and fuel a little more growth for their startups.

So the Taxation regime in India can be categorized into two broad heads:

  1. Direct Taxation (Taxation on the Income of the Business – Income Tax)
  2. Indirect Taxation’s (Taxation on the Value addition, mainly includes Goods and Services Tax (GST))

The benefits to the Startups have been scattered under these two categories. Here we will have a look at the benefits provided in the Direct Taxation Regime one by one.

  1. Tax Benefits to Startups under DIRECT TAXATION regime (INCOME TAX):
    Direct Taxation means the tax on the Income of the operations of the business. There are various benefits given to the startups under the Income Tax Act, also there are few pre-condition for availing the benefits. Let’s have a look at the benefits:
  • Tax Holiday Scheme to the Startups and Small Businesses {U/s 80 IAC of the Income Tax Act}
  • Angel Tax Benefits {U/s 56(2)(viib)}
  • Tax exemption to Individual/HUF on investment of long-term capital gain in equity shares of Eligible Startups {U/s 54GB}
  • Set off of carrying forward losses and capital gains allowed in case of a change in Shareholding pattern.

Before getting into the details of the benefits provided. One needs to know the meaning of the ELIGIBLE STARTUP as per the Startup India rules and also the prescribed registration procedure to be one of the Eligible Startups.

Eligibility criteria for Startup Recognition:

  • The Startup should be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership.
  • Turnover should be less than INR 100 Crores in any of the previous financial years.
  • An entity shall be considered as a startup up to 10 years from the date of its incorporation.
  • The Startup should be working towards innovation/ improvement of existing products, services and processes and should have the potential to generate employment/ create wealth. An entity formed by splitting up or reconstruction of an existing business shall not be considered a “Startup”.

To apply for being an eligible startup one needs to file an application which can be filed using the Startup India Mobile App or Website, Application needs to be accompanied by a Certificate of Incorporation or Registration, a write-up mentioning the nature of the business and explaining that how the business model is going to achieve innovation, development, employment creation, etc. DPIIT (Department for Promotion of Industry and Internal Trade) after calling for further explanation may recognize the Eligible business model as Startup.

After receiving the registration certificate of being an Startup you are now all set to avail the benefits provided under the Income Tax Act. Lets have a look at each of them one by one.

Tax Holiday Scheme to the Startups and Small Businesses {U/s 80 IAC of the Income Tax Act}

After getting recognition a startup may apply for Tax holiday scheme under Section 80 IAC of the Income Tax Act. Section 80 IAC speaks as follows:

Objective: Providing an incentive to the ELIGIBLE STARTUPS to aid their growth in the early stage.

Quantum of Deduction: 100% of the profit and gains to the ELIGIBLE STARTUPS for ELIGIBLE BUSINESS.

Period of Deduction: For 3 consecutive assessment years out of 7 years beginning from the year in which eligible Startup is incorporated.

That means Startups don’t need to pay any part of their profit as Tax to the Government for 3 consecutive years and it’s their option to choose the 3 year period out of the 7 year period. So one can estimate and choose the 3 most profitable years for the exemption which is commonly the last 3 years as in the starting age startups barely make any profit so a good help to the young age business models.

One more thing to consider over here and in the text of section 80 IAC as highlighted above is the definition of Eligible Business and Eligible Startup. Here I am quoting the direct text as mentioned in the text of the act.

Eligible startup: “eligible start-up” means a company or a limited liability partnership engaged in eligible business which fulfills the following conditions, namely:-

(a) it is incorporated on or after the 1st day of April 2016 but before the 1st day of April 2021
(b) the total turnover of its business does not exceed twenty-five crore rupees [in the previous year relevant to the assessment year for which deduction under this section is claimed]; and
(c) it holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government

Eligible Business: “eligible business” means a business carried out by an eligible start-up engaged in innovation, development, or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation. So if any Startup fulfills the above conditions it gets a Tax Holiday for 3 years and hence fuels a little growth for itself.

Angel Tax Benefit under Section 56(2)(viib) of the Income Tax Act:

Section 56 of the Income Tax act talks about taxing Income from other sources of the assesses. And specifically talking about the clause 2 and sub-clause viib of the Section 56, it taxes the income of the person who holds the shares of private limited company and he receives any consideration for such shares which exceeds the face value of shares. Then such differences of the consideration and face value of shares are taxed under the head Income from other sources.

Let’s take an example to understand it better:
Suppose a person buys 100000 shares of a Private Limited Company with the face value of Rs. 10 each which amounts to Rs. 10,00,000/-. Now if the person sale the shares for Rs. 15 each that means for Rs. 15,00,000/- for 1,00,000 shares. The difference of Rs. 5,00,000/- gets taxed under the head Income from other sources under section 56(2)(viib).

Due to this, the Angel Investors had to face tax implication which made their exit a little expensive and the ultimate bearer of this tax implication were the Startups themselves so the Government to remove this hardship included an exclusion to the Section 56(2)(viib) which mentions as follows:

“This clause shall not apply where the consideration for issue of shares is received by venture capital undertaking from a venture capital company or a venture capital fund”

Therefore removing the tax on Angel Investors and providing the Startups with Indirect but necessary benefit.

Tax exemption to Individual/HUF on investment of long-term capital gain in equity shares of Eligible Startups {U/s 54GB}

With the increasing number of Startups in India, one problem that the Startups face is to fund their operations at least at an early age where funding from the market is not easily available the early operation are usually funded by the startup founders by selling their properties and other assets but again since the gain on selling these assets and properties are taxed as Capital Gains which takes away a part of the funds that were about to be used for the early age operations of the startup.

To reduce this hardship a section 54GB was amended and introduced which says that an Individual and HUF if sell a property and have a Long Term capital gain out of such property then such Long term Capital Gain shall not be taxable if the net consideration received from selling the property is utilized for the subscription of the Equity shares of an Eligible Company and the Company utilities such money for acquiring the assets for the company within one year from the date of such subscription.

But again here also the concept of Eligible Company comes into the picture. And to be an eligible company following conditions to be fulfilled:

  • It is a company incorporated in India during the period from the 1st day of April of the previous year relevant to the assessment year in which the capital gain arises to the due date of furnishing of return of income under sub-section (1) of section 139 by the assesses; (In simple words, if the asset is sold in September 2019 than the company must be incorporated between 01st of April 2019 to the due date of furnishing of return of income tax for the financial year 2019-20)
  • It is engaged in the business of manufacture of an article or a thing or in an eligible business
  • It is a company in which the assesses has more than 50 percent share capital or more than 50 percent voting rights after the subscription in shares by the assesses; and
  • It is a company that qualifies to be a small or medium enterprise under the Micro, Small and Medium Enterprises Act or is an eligible start-up

So if an individual fulfills the mentioned conditions then an amount received from selling the personal asset shall be used in funding the operations of the Startup and that too free of tax.

Set off of carrying forward losses and capital gains allowed in case of a change in Shareholding pattern.
As everyone knows in the early stage of the startup, these models usually incur losses in their early stages and after some years finally, they come into profitable situations, so here comes section 79 of the Income Tax Act which mainly talks about Set-Off and Carries Forward of Losses.

The concept of section 79 is that suppose there is a Company which incurs losses in its first 2 years amounting to Rs. 2 Crore in 1st year and Rs. 1.5 crore in 2nd year that means Rs. 3.5 crore in aggregate for 2 financial years. Now eventually suppose in the 3rd financial year the company achieves a profit of Rs. 4 crores now the company needs to pay Income tax on its Income which in such cases shall be Rs 50 Lacs only (Rs. 4 Crore – Rs. 2 Crore – Rs. 1.5 Crore) i.e. the losses you incurred earlier gets set off from the profit you achieve in further years. But this benefit is subject some condition which involves that such losses can be carried forward only when all the shareholders in the financial year of losses continue to be shareholders in the year of financial years, which is little difficult in case of startups as according to the culture of the startups the shareholders and their ownership ratio changes very frequently thus keeping them outside of the purview of the benefit which is again a hardship. So to remove this hardship the law was amended and an exception to the normal clauses was introduced and it’s now easier for the startups to set off and carry forward the early stage losses with the profits in further years.

So these are few benefits that have been provided to the Startups in India. To be true these perks are some very necessary jacks to the Startup culture and the ecosystem which will definitely help it to grow like never before.

CA Mukul Verma
Financial Expert
Bhopal, India