The numerous benefits of registering a startup form a promising narrative of the government to support the entrepreneurial ecosystem, enabling jobs and innovations.
We may all intuitively understand the benefits of registering as a startup with the Department for Promotion of Internal Trade and Industrial Policy (DPIIT). The benefits listed here form a promising narrative of the government to support the entrepreneurial ecosystem, enabling jobs and innovations.
However, the chink in the armour are administrative hurdles. In our experience, especially with respect to Section 80IAC exemption, we noted excessive time delays in the process. Reportedly, in January 2019, only 4 percent of startup applicants got tax breaks within the first 30 months of the Startup India initiative.
More can be done to ensure that the benefits trickle down to a wider base.
1. Exemption under Section 56(2)(vii)(b) of the Income Tax Act, 1961
Under the Income Tax Act, 1961, where a company receives any consideration for issue of shares which exceeds the fair market value of such shares, such excess consideration is taxable in the hands of the recipient as income from other sources.
The exemption that is available to a registered startup is the levy of tax on this excess consideration. This exemption is particularly beneficial at the stage of an angel/VC round, where the angel or VC invests at the excess of the fair market value.
Typically, angel investors enter the scene when actual assets are meagre and the preferred valuation method is that of discounted cash flow which would value the business higher than at fair market prices. The discounted cash flow method takes into consideration the time value of money, i.e., the expected returns from the date of investment.
To illustrate, let’s say that a startup receives an investment of Rs 50 crore for one lakh shares at Rs 5,000 per share, assuming the fair market value of the shares to be Rs 2,000 per share. Therefore, at the fair market value, the startup should receive an investment of only Rs 20 crore but on a discounted cash flow method, the startup can raise an additional Rs 30 crore.
Pre-exemption regime would mean the startup would need to pay Rs 9 crore, however post-exemption, the tax is nil. (For convenience, the applicable surcharge deduction has not been shown here.)
2. Exemption under Section 80-IAC
A registered startup can avail of an exemption from payment of income tax for three consecutive years out of the first 10 years from the date of its incorporation.
The benefit is self-explanatory, and the seeming purpose is for a startup to be able to re-invest in the company, assuming good profits in these consecutive years. This is especially useful for a startup.
Of course, the total turnover of the startup in the relevant assessment year for which deduction is being claimed must not exceed Rs 25 crore.
3. Exemption under Section 54(GB)
Section 54GB relates to tax on long-term capital gains received upon the sale of a residential property of an individual. The government has exempted individuals from payment of this tax if such long-term capital is invested in a registered startup.
There is a rider attached to this kind of investment: first, the assessee must have more than 50 percent of the share capital or voting rights (the union budget had proposed decreasing this to 25 percent) after the investment and second, the startup must use the amount invested to purchase assets and should not transfer assets purchased within five years from the date of its purchase.
Given these, it would make sense only if the investor has substantial control over the startup, otherwise there is no benefit of the exemption.
Often, specifically during the initial stages where founders are striving to establish proof of concept or consolidate their business idea, there is a vacuum in funds available to them. This particular exemption strives to cushion founders and/or friends and family of founders who intend to leverage residential property to infuse funds in the company.
4. Self-certification under labour and employment laws
Any private limited company, per law, is ordinarily bound by labour and employment laws. Among others, officers under certain specific acts are required to conduct an inspection of the company concerning the registration of establishments, maintenance of establishment in terms of safety norms, compliance with employee beneficial norms like payment of gratuity, and insurance cover.
A registered startup is allowed to self-certify their compliance under six labour laws and three environment laws. This is allowed for a period of five years from the date of incorporation of the entity.
The self-certification will be applicable in various instances, ranging from contribution to employee state insurance, allowances to contract labourers, and migrant workers under relevant laws.
These exemptions on inspection are on the following labour laws:
The Building and Other Construction Workers’ (Regulation and Employment and Conditions of Service Act, 1996);
The Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Act, 1996;
The Payment of Gratuity Act, 1972;
The Contract Labour (Regulation and Abolition) Act, 1970;
The Employees Provident Funds and Miscellaneous Act, 1952; and
The Employees State Insurance Act, 1948,
Exemption on inspection is allowed on the following environmental laws:
The Water (Prevention & Control of Pollution) Act, 1974;
The Water (Prevention & Control of Pollution) Cess (Amendment) Act, 2003; and
The Air (Prevention & Control of Pollution) Act, 1981.
5. Registration of Intellectual Property
Did you know that an application to the trademark registry in India for a trademark in one class costs Rs 9,000? Given the financial incapability, the fees for a startup registered with DPIIT would be half the price.
Similarly, in the case of a patent application, the government fee is in the range of Rs 8,000/- to Rs 11,000/- depending on the nature of the patent but for a registered startup, it starts at INR 1,800. Further, the recognised startup will be eligible to claim a rebate of 80 percent of patent fees.
6. Relaxation in public procurement norms
A DPIIT registered startup may bid for government contracts with fewer eligibility requirements. This can even work on a trial basis.
The present categories that are listed in this regard are, for example, computers, automobiles, and office supplies. So if a startup manufactured and supplied ball pens, it could bid for a contract calling for ball-pen suppliers but with reduced eligibility requirements.
Public procurement refers to the process by which governments and state-owned enterprises purchase goods and services from the private sector. Government contracts are usually marked by high eligibility requirements and therefore, often only established entities may participate in the bidding process.
To allow startups to participate in public procurement, the eligibility conditions of prior turnover and/or demonstration of experience and security cover for projects have been exempted depending on the goods or services.
Upon acceptance, such DPIIT recognised startups can register on the government e-marketplace (GEM)
Source - YOURSTORY