Income-tax Benefits for Startups

India hosts 55000 start-ups and is the world’s third-largest pool. We have 59 unicorns amongst them. Aided by the digital revolution, the start-ups are expanding in number and scale. The Government has aided this rally through a slew of initiatives. The tax incentives and effective redressal of issues like angel tax deserve special mention. The startups differ from traditional businesses. They are focused on innovation, technology, and exponential scaling. Therefore, their tax issues are also slightly different from other businesses.

What is an ‘eligible start-up’ for Income tax benefits?

The tax benefits are not available to all the start-ups but the eligible start-ups defined in the Income-tax Act. Section 80IAC has defined a ‘start-up’. It has to meet certain conditions – 

It should be constituted either as a company or an LLP. It should be incorporated between 01.04.2016 and 01.04.2022. It should have innovative products and services with the potential to create employment and wealth. The total business turnover should be below rupees 100 crores in the year of claiming benefits. It should be certified by the Inter-Ministerial Board of Certification of Central Government.

Tax holiday for Any 3 Out of 10 Years Since Formation

An eligible start-up can claim a 100 per cent deduction against its business income for consecutive 3 years. These can be any 3 years out of 10 years since its incorporation. This deduction can not be claimed in different years with a break in between. The eligible business or startup must not have been formed by splitting or reconstruction of another business. The plant and machinery used in any other business cannot be used. In case, the startup opts to pay tax at the concessional rates of 22 per cent (15 per cent in the case of manufacturing domestic companies), then this tax benefit cannot be availed. The start-up claiming this benefit may need to pay tax under Minimum Alternate Tax (MAT) at the rate of 15 per cent of the book profits. 

To claim this benefit, a start-up must apply through Form – 1 to the Inter-Ministerial Board of Certification of Central Government on www.startupindia.gov.in. Once it is recognized as an eligible start-up, the said tax benefit can be claimed in the Income-tax return.

Relaxed Conditions for Set-Off of Loss

For private companies, section 79 of the Income-tax Act lays down conditions for setting off the carried forward losses against income of future years. The loss can not be set off if the company has 51 per cent or more shareholders different in the two years i.e the year of incurring loss and setting it off against income. This means that the company must have at least 51 per cent same shareholders in the year of setting off of a loss as they were in the year in which the loss was incurred. 

This condition is relaxed in the case of an eligible start-up company from the financial year 2019-20. The loss can be set off if you satisfy any of the two conditions, one, the 51 per cent voting power shareholding continues, all the original shareholders must be existing in the year of setting off of a loss. In the latter case, the percentage of shareholding does not matter. However, such losses should have been incurred within seven years of incorporation of a startup. In case, the start-up continues to use the first condition (51 per cent continuity), then all other conditions shall be the same as other private companies. 

Roll-Over Deduction Against Capital Gains 

If you earned capital gains from the sale of a residential property, you can claim a deduction against this income if the sale proceeds are invested in shares of a start-up company. This benefit is available only to the individuals and Hindu Undivided Family (HUF). Such a start-up company should be classified as MSME and has an investment in plant and machinery between rupees 25 lakhs and 10 crores. The shareholding of such an investor must not be lesser than 25 per cent in the start-up company. The invested amount must be utilised by the company within a year in the purchase of new plant and machinery, not the ones installed in office or residence but includes computers and software for technology start-ups. The investor should not sell the shares of the start-up within 5 years of investment. Also, the company should not sell the asset acquired through this money within 5 years. This deduction is available in case of the residential property is sold before 31/03/2022. The entire amount of capital gains is tax-free if the net sale consideration from the sale of residential property is equal to or lesser than the investment amount. If the net consideration is more than the investment amount then the tax-free capital gains shall be of equal proportion to the proportion of investment to net sale consideration.

Deferral of Tax Payment on ESOPs

ESOPs are the components of the salary package and CTC. So, these are taxed as income from salary. Section 17(2) of the Income-tax Act has classified the ESOPs as ‘perquisites’. The value of such perquisites is taxed as income from salary in the hands of employees. The value of such ESOPs is computed as per Rule 3(8)(ii) of Income-tax Rules. The value of ESOPs is determined as on the date of exercise of options and not on the date of allotment. However, the tax payment liability is relevant to the date of allotment shares. The employer was required to include this value in the CTC of the employee and deduct TDS thereon in the year of allotment. This is the first incidence of tax on ESOPs in the hands of allottees. The second incidence of tax on ESOP arises when the allottee sells those shares. 

From the financial year 2020-21, the relaxation is provided in respect of the first incidence of tax i.e. income from salary with TDS thereon but the second incidence of tax i.e. income from capital gains stays. The tax amount on the income component related to ESOPs need not be paid by them while filing ITR nor does the TDS needs to be deducted by the employer on this component. This payment is deferred. So, from the financial year 2020-21, the TDS shall not be deducted nor the tax on the said income be paid while filing ITR next year. However, tax needs to be paid within 14 days from any of the following events, whichever is earliest: after the expiry of 48 months from the end of the relevant assessment year; or the date of the sale of such ESOP shares by the assessee; or from the date of the taxpayer ceases to be the employee of the ESOP allotting employer.

In case the employer did not deduct TDS as per the above dates, then the allotted himself must pay the tax according to the same dates. The rates of tax and TDS in such cases shall be the ones applicable for the year in which ESOP was allotted.

Angel Tax

This issue has caused anxiety in the startup ecosystem. However, the steps taken by CBDT through Circular 16/2019, on this issue have relaxed the same. Angel tax is levied on a private company when it issues shares to a resident at a value more than a fair market value of such shares. This is levied as per section 56(2) (viib) of the Income-tax Act. To avoid this situation, a startup must do this:

• file a declaration in Form 2 with DPIIT, GoI seeking recognition as eligible startup
• file details of incorporation, shareholders, self – declaration in PDF on company’s letterhead. 
• This declaration is forwarded by DPIIT to CBDT for approval.
• Once the acceptance from CBDT is received, a start-up can issue the shares.

However, before this Circular, many of the assessments are completed and angel tax is levied and appeals are pending. In such cases, the CBDT has directed not to recover the demands. Such appeals are to be disposed on priority and once the appeal is allowed by the Commissioner, a further appeal shall not be preferred by the Department. In case of pending assessments, it is directed by the CBDT that no enquiry on this issue be carried out in the case of recognized start-ups. 

Concessional Tax Rate and No MAT

For the assessment year 2020-21 and onwards, the domestic companies can opt for concessional tax rates of 22 per cent. This comes to 25.17 per cent including surcharge and cess. If the company opts for this scheme, then it cannot claim other deductions and exemptions except very few specified ones. The company can also not claim the set-off of brought forward losses. These companies are however not required to pay tax under minimum alternate tax (MAT).

The author is Founder, Taxbuddy.com

DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.