Income Tax benefits for start-ups in India

In this article, we are discussing the word ‘Startup’ which no one was aware few years back especially in Tier-2 & Tier-3 cities but now it has become a well-known word even amongst the kids. Who could have expected that we will watch T.V. programs like ‘Shark Tank India’? Thanks to the vision of our Honourable Prime Minister Sh. Narendra Modi & his ambitious program ‘Startup India’, that we are seeing a surge in new technology startups coming up in India and fastly becoming ‘Unicorn’. Our focus in this article is on ‘Income tax benefits available for startups’ so that aspiring young entrepreneurs can take advantage and fulfill their dreams to the fullest.

Before knowing about the benefits to start-ups under Income Tax Act, you might be interested to know about eligibility for start-ups in India. So, first, we will discuss the eligibility criteria for ‘Startup India’ and then move ahead on the main issue.

Eligibility for Startup India Recognition

Tax benefits allowed to Eligible Startups

Income Tax Act, 1961 allows the following exemptions and incentives to the startups in India:

Tax holiday for 3 years- Section 80IAC

An eligible start-up can avail a deduction of 100% of its profits for a block of 3 consecutive years as per the provisions of section 80IAC of the Income Tax Act. The following points are to be noted in this regard:

• Eligible start-up for this section means a company or a limited liability partnership firm
• It must be incorporated on or after 01-04-2016 but before 01-04-2022
• It must hold a certificate from the Inter-Ministerial Board of Certification i.e. it must possess DPIIT certification
• The total turnover of its business does not exceed Rs. 100 crores in the year in which deduction is claimed

On fulfillment of all the above conditions, the eligible start-up can claim a 100% deduction of their profits for a block of 3 consecutive years of their choice out of the first ten years of its incorporation.

Waiver from ‘Angel Tax’

As per the Income Tax Provisions, the domestic companies in India are required to issue their shares at fair market value (FMV) which is determined on the net asset basis or discounted cash flow basis determined by the merchant banker. If any company receives any amount in excess of such FMV, the excess premium is subject to tax in the hands of the company. This is popularly known as ‘Angel Tax’.

However, the Government has exempted angel tax i.e. tax levied on shares issued above the FMV in case of eligible start-ups. Such investments include investments made by resident angel investors, family or funds which are not registered as venture capital funds.

We would certainly cover the topic “How to get a waiver from Angel tax” in a subsequent article.

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Exemption from tax on Long Term Capital Gains- Section 54EE

A new section 54EE has been inserted by the Government in the Income Tax Act for the eligible start-ups to exempt their tax on a long-term capital gain if such a long-term capital gain or a part thereof is invested in a fund notified by the Central Government within a period of 6 months from the date of transfer of the asset. The following points are to be kept in mind for exemption u/s 54EE:

• The maximum amount that can be invested in the long-term specified asset is RS. 50 Lakhs.
• Such amount shall remain invested in the specified fund for a period of 3 years.
• If withdrawn before 3 years, then the exemption will be revoked in the year in which the amount is withdrawn.

Exemption from tax to individual/ HUF on investment of long-term capital gain in equity shares of eligible start-ups- Section 54GB

The existing provision u/s 54GB allows the exemption from tax on long-term capital gains on the sale of a residential property if such gains are invested in the small or medium enterprises as defined under the MSME Act, 2006. But now the definition of 'eligible company' is amended to include the eligible start-ups also.

Therefore, if an individual or HUF sells a residential property and invests the capital gains to subscribe 25% (earlier 50%) or more equity shares of the eligible start-ups, then tax on long-term capital gain will be exempted in the hands of such individual or HUF.

However, the exemption from tax will be subject to the condition that such shares are not sold or transferred within 5 years from the date of its acquisition. Further, the eligible start-up shall also use the amount invested by the individual/ HUF to purchase assets and should not transfer assets purchased within 5 years from the date of its purchase.

Set off of carry forward losses and capital gains allowed in case of a change in shareholding pattern

The carryforward of losses in respect of eligible start-ups is allowed if all the 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 the previous year in which such loss is to be carried forward. The restriction of holding of 51% of voting rights to be remaining unchanged u/s 79 has been relaxed in the case of eligible start-ups.

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Angel Tax Exemption for Startups

Disclaimer: The above article is only for educational purposes and has no persuasive value. Readers are therefore requested to act diligently and under consultation with any professional before applying the information contained in this article.