FEBRUARY 15, 2016

By Aparna Parelkar & Dipika Shah

STARTUP entrepreneurship has gained momentum in India over past one year. Looking at the potential around startups the Government coined "Startup India" and in the beginning of the year launched an action plan for startups giving a ray of hope to individuals with innovative ideas,zeal and urge to take risk to achieve success in unexplored business zones.

Important points of start-up action plan indicated:

•  Allowing self-certification underlabour & environment laws,

•  Creating startup hub being center point for knowledge exchange to foster innovative ideas,

•  Easy registration of startup,

•  Relaxed norms for patenting, public procurement and exit doors for startups,

•  Going an extra mile PM also gave thought on tax benefits that can be made available to individuals venturing into startups by:

•  exempting from capital gains tax for persons who invest in Fund of fund recognized by Government,

•  keeping out startups entrepreneurs from the entire gamut of tax for initial three years and

•  extending exemption under section 56(2)(viib) to incubators in the startups.

Considering the policy initiative, many features may need to be augmented by incorporating the required provisions in the Finance Act in Budget 2016.

In Budget 2016

•  The Finance ministry may introduce a new section or widen scope of existing sections in Chapter IV clearly delineating the taxpayers,investing in the Funds recognized by the Government, eligible for capital gain tax exemption. As proposed the exemption under Section 54GB would be extended to investment in startup and new asset will include computer or computer software. The definition of computer or computer software should be clearly drafted to avoid ambiguity. The period within which the investment/purchase in new assets should be made should be convincing and realistic considering the peculiar characteristics of startups.

•  The scheme indicates that startup entrepreneurs will be spared from tax for initial three years that means no tax to be paid on any profits earned by startups in first three years of its operations. However, looking at realistic scale and even in present scenario of existing startups, 90% of the startups hardly earn any profits or struggle to break-even in the early years of its business. For this reason granting tax holiday for first three years may not have the desired effect and may just bean illusory provisions for the startup entrepreneurs. Subsequent to Action Plan 2016 ministry came up with clarification that three year tax holiday will be out of five year period. However, it is felt that it may still not be sufficient to encourage startups.

Finance ministry taking pragmatic view should include in the statute on profit linked tax holiday by exempting 100% profits for five years out of seven years period looking at the time frame involved in achieving break-even by startups.

The startup scheme provides further that a Startup shall be eligible for tax benefits only after it has obtained certification from the Inter-Ministerial Board, setup for such purpose. Presently tax holiday (Section 10A/10B) are denied for want of or delay in required approvals leading to litigation. Such situations should be avoided for startups.

Further, Budget 2016 could come out with stipulations defining the eligible taxpayers who can claim tax holiday and computation mechanism of eligible profits. The provisions could be exhaustive and futuristic to take impact of any probable takeovers, amalgamation/demergers etc. by startups entities. The nature of activities like manufacture / service industry etc.may also be defined while defining ‘startups'. During the initial years, considering the novel business ideas by startups, there is always a risk of incurring huge losses and hence provisions should be beneficial to allow carry forward and set off such losses with business income or other income..The complications in present tax holiday sections surrounding the eligible businesses, carry forward and set off of losses, impact on account of demerger/amalgamation, computation of total income/profits etc., could be minimized by formulating the well-defined provisions such that the idea behind easy or hassle free startups is sustained.

•  The benefit currently available to venture capital undertaking, venture capital funds or venture capital company from non-application of provisions of section 56(2)(viib) wherein consideration issued on receipt of shares above fair market value could be extended to benefit the Incubators of the startups.

Apart from the above expected tax benefits which are already highlighted in Startups action plan. further benefits which may be considered are:

•  To encourage individuals to join startups such that startups have good employee base to execute and support their business process; attractive employee stock options (ESOP) schemes should be granted by startups. In order to make granting of ESOPs effective; introduction of tax benefits by disregarding perquisite taxation in hands of individual employees at the time of exercising of ESOPs during vesting period. Tax can be imposed only on capital gains earned by individuals at the time of sale.

•  Relief from TDS/TCS provisions in initial years so that compliance burden is reduced,

•  Retention of weighted average deductions on research & development expenses incurred for startups entrepreneurs

•  Benefit of carrying forward of losses from business/capital gains for period of 10 years and

•  Deductions that can be made available to startups after expiry of three years tax holiday period since break-even in startups may take a long time.

•  Further the concept of self-assessment for initial three years to be introduced to avoid litigation burden on startups,

•  Simple process and form for return filing.

Startup India is introduced with a view to foster innovative ideas and hence the Government is also expected to be more innovative in introducing tax provisions for startups with a view that startups can dedicatedly work towards their ideas and dreams. Regulatory laws like company law, FEMA income tax and indirect tax should be liberalized to be pro Startup India and Standup India.