Funding your Dream: Tax Exemptions for Start-Ups

In India, start-ups can get special tax benefits that are designed to help them grow. But, it’s important to know that these benefits have certain conditions and are only available to startups that the government officially recognizes. The goal of these tax advantages is to give startups a big push, helping them overcome challenges in starting and running a business in the competitive market. These incentives are crucial for helping startups grow and succeed in the business world.

Tax Benefits and Recognition by DPIIT

An entity qualifies for specific benefits if it attains the status of an ‘Eligible Start-up,’ and to achieve this designation, the entity must fulfil various conditions outlined in Notification No. GSR 127(E), dated 19-2-2019, issued by the DPIIT.

While additional conditions exist for claiming particular benefits or relief under the Income-tax Act, it is imperative for an entity to be officially recognized by the DPIIT to be eligible for such benefits.

Start-Up

As per the notification issued by the DPIIT, an entity is considered as a Start-up up to a period of 10 years from the date of its incorporation/registration if the following conditions are satisfied:

1.  It is incorporated as a private limited company, partnership firm, or LLP in India;
2. Turnover of the entity for any of the financial years since incorporation does not exceed Rs. 100 crores;
3. It is working towards innovation, development, or improvement of products or processes or services or business model of the entity is scalable with high potential of employment generation or wealth creation; and
4. It is not formed by splitting up or reconstructing an existing business.

Read More: Relevance Of Due-Diligence For Start-UPs

Tax Benefits to Start-Ups

The following benefits shall be available to an eligible start-up recognised by the DPIIT:

1. Exemption to the company from levy of angel tax under Section 56(2)(viib)
2. Deductions under Section 80-IAC to the start-up
3. Liberalised regime of Section 79 to carry forward and set off the losses of start-up

I.ANGEL TAX EXEMPTION [Section 56(2)(viib)]

Angel tax is a term used for the tax payable by a closely held company under Section 56(2)(viib). This tax is payable in respect of any excess premium received by a company from the issue of shares provided the following conditions are satisfied:

1.  Shares (equity or preference shares) are issued by a closely held company;
2. The consideration for the issue of shares is received from any person; and
3. The consideration received for the issue of shares exceeds the face value and fair market value of shares.

Conditions prescribed by the DPIIT

The above-mentioned conditions did not apply to an eligible start-up that fulfils the conditions prescribed in the Notification issued by the DPIIT. So a company registered with DPIIT shall get an exemption from the angel tax if it fulfils the prescribed conditions given below.

1. Condition as to the ‘paid-up share capital’

The aggregate amount of paid-up share capital and share premium of the start-up, after the issue or proposed issue of shares, should not exceed Rs. 25 Crores. While calculating this threshold limit, the issue of shares to the following persons shall not be includes:

1. A non-resident person;
2. Venture Capital Company;
3. Venture Capital Fund; and
4. Listed Company whose net worth exceeds Rs. 100 Crores or turnover exceeds Rs. 250 Crores for the financial year preceding the year in which shares are issued.
5. Condition as to the ‘utilisation of funds’

The eligible start-up should not invest in any of the following assets for a period of 7 years from the end of the latest financial year in which the shares are issued at a premium:

1. Land or building, being a residential house, other than that used for the purposes of renting or held as stock-in-trade in the ordinary course of business;
2. Land or building, not being a residential house, other than that occupied by a start-up for its business or renting purposes or held as stock-in-trade in the ordinary course of business.
3. Loans and advances, if a start-up is not engaged in the ordinary business of lending of money;
4. Capital contributions to any other entity;
5. Shares and securities;
6. Motor vehicle, aircraft, yacht, or any other mode of transport, if the cost of such an asset exceeds Rs. 10 lakhs other than that held by the Start-up for the purpose of plying, hiring, leasing, or as stock-in-trade in the ordinary course of business;
7. Jewellery held otherwise than as stock in trade; and
8. Archaeological collections, drawings, paintings, sculptures, any work of art or bullion.

Read More: CBDT Announces Angel Tax Verification Exemption for DPIIT Recognized Start-Ups

How to claim the exemption from angel tax?

The exemption from the application of angel tax is applicable to all shares issued by the start-up from its incorporation date, excluding shares for which an addition under section 56(2)(viib) has been made in an assessment order before the notification’s issuance.

To avail this exemption, the start-up must submit a declaration in Form 2 to the DPIIT, providing details such as the company’s name, date of incorporation, registration/incorporation number, contact information, etc. This form must include a self-declaration in PDF format, printed on the company’s letterhead, and digitally signed by the authorized signatory.

The DPIIT will forward the self-declaration to the CBDT for approval. Following a successful submission, the start-up can proceed to issue shares. Subsequently, the CBDT will evaluate the application, deciding to either accept or reject it after offering an opportunity for a hearing.

Read More: All you need to know about recent Delhi High Court Judgment giving relief to Startups from Angel Tax on alleged Premium

Withdrawal of exemption

If the start-up invests in any of the specified assets before the conclusion of 7 years from the conclusion of the latest financial year in which shares are issued at a premium, the exemption outlined in section 56(2)(viib) will be retroactively revoked.

Upon the withdrawal of this exemption, the consideration received from the issuance of shares, exceeding the fair market value of such shares, will be deemed as the company’s income subject to taxation for the preceding year in which the exemption is withdrawn. This income, resulting from the exemption withdrawal, will be considered under-reported by the company due to misreporting, leading to the imposition of a penalty equivalent to 200% of the tax payable on the under-reported income (i.e., the discrepancy between the issue price and the fair market value of shares) in accordance with Section 270A.

II.DEDUCTION UNDER SECTION 80 IAC

An eligible start-up is entitled to a deduction under Section 80-IAC, which is applicable up to 100% of its profits and gains for three consecutive assessment years within the initial ten years commencing from the year of incorporation or registration. It’s important to note that the definition of an eligible start-up in this context may diverge from the definition stipulated in the DPIIT’s notification.

How to claim the deduction

To qualify for a deduction under Section 80-IAC, an eligible start-up is required to procure a certificate by submitting an application in Form-1, along with the required documents, to the Inter-Ministerial Board of Certification through the DPIIT.

The Inter-Ministerial Board, established by the DPIIT to authenticate start-ups for the purpose of conferring tax-related benefits, is responsible for validating start-ups for the Income-tax exemption under Section 80-IAC of the Act. The DPIIT, following the solicitation of necessary documents or information and conducting inquiries as deemed appropriate, has the authority to either grant the certificate or reject the application, providing reasons for the decision.

How to file the form for Section 80-IAC approval

Step 1: Log in to https://www.startupindia.gov.in/

Step 2: Go to Recognition>Apply for Tax Exemption

Step 3: Click on apply for Income Tax Exemption

Step 4: Fill in the details, attach the files, and submit the application.

III.LIBERALISED REGIME FOR THE CARRY FORWARD OF LOSSES

The losses sustained by a closely held company in any year before the preceding year cannot be carried forward and offset against the income of the prior year unless the same individuals beneficially held shares of the company, representing at least 51% of the voting power, on two specific dates following the previous year:

1.  On the last day of the previous year in which loss was incurred;
2. On the last day of the previous year in which such brought forward loss has to be set off.

In case of an eligible start-Up

Meaning of eligible start-Up

This provision makes a reference to Section 80-IAC for the meaning of an eligible start-up. It means a company which fulfils the following conditions:

• It is incorporated between 01-04-2016 and 31-03-2024;
• The total turnover of its business does not exceed Rs. 100 Crores in any of the previous years during April 1, 2016, and March 31, 2024; and
• It holds a certificate of eligible business from the Inter-Ministerial Board of Certification.

‘Eligible business’ means a business which involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property.

If a company does not fulfil any of the conditions as mentioned above, it will not be regarded as an eligible start-up for Section 80-IAC. Thus, if the turnover of a company exceeds the threshold limit, it becomes ineligible not only for Section 80-IAC but also for Proviso to Section 79. Consequently, such companies, if they are closely held companies, can claim the set-off of losses in accordance with general provisions.

When can losses be carried forward and set off?

The losses incurred by an eligible start-up shall be allowed to be carried forward and set off against the income of the previous year on the satisfaction of any of the two conditions specified below:

Condition 1: Continued 51% shareholding

During the year when losses are offset, it is required that the same individuals who held at least 51% of the voting power on the last day of the year in which the loss was incurred continue to beneficially hold the voting power.

Condition 2: Continued 100% shareholders

100% of shareholders, on the last day of the previous year in which the loss was incurred, should continue to hold their shares on the last day of the previous year in which the loss is to be set off. Further, such losses should have been incurred during the period of 10 years beginning from the year of incorporation of the company.

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