Startup Tax Exemption Under Startup India Initiative

Startup tax exemption is one of the major highlights of the Startup India Action Plan unveiled by The Prime Minister Shri. Narendra Modi at the Startup India event held in Delhi on 16th January 2016. Tax exemption for a startup is provided under three different schemes and in this article, we look at those tax exemptions for Startups in detail.

Three Year Tax Exemption for Startups

Startups in their initial years, struggle with cash flow as they work on turning ideas into commercially viable products or services. Bootstrapped startups incur expenditure in terms of rental, equipment, salaries, taxes and more, which are most often funded by savings of the Entrepreneur. To provide better chances for Startups to succeed and to increase the number of Entrepreneurs, it is important for the Government to reduce the burden on the Entrepreneur.

Thus, Startup India Action Plan has announced a three-year income-tax exemption for Startups to help them grow and meet their working capital requirements during the initial years of operations. The startup income tax exemption is subject to the non-distribution of dividend by the Startup.

Tax Exemption on Capital Gains

Equity funding for startups is limited in India as it is a new concept gaining traction just over the last few years. Also, due to the high-risk nature, startups find it hard to attract investment in its initial stage. Hence, to provide an impetus to investors to invest in Startups and to create a vibrant investor community, the Startup India Action plan has announced tax exemption on capital gains. Under this scheme, tax exemption will be given to persons who have capital gains during the year, if they have invested such capital gains in the Funds of Funds recognized by the Government. This is help increase the funds available with various VCs and Angel Funds, thereby providing better availability of capital for Startups.

In addition, existing capital gain tax exemption for investment in newly formed manufacturing MSMEs by individuals shall also be extended to all Startups. Currently, such an entity needs to purchase "new assets" with the capital gain received to avail such an exemption. Under the new tax exemption scheme for startups, investment in "Computer or Computer Software" would also consider as the purchase of "new assets" in order to promote technology-driven startups.

Tax Exemption on Investments above Fair Market Value

Under the Income Tax Act, 1961, if a startup or company receives any consideration (money) for issue of shares which exceed the fair market value of the shares of the company, then receiving such excess amount over the fair market value is taxable in the hands of the recipient (Startup) as Income from Other Sources.

However, in most cases, the fair market value of shares of a startup is hard to exactly calculate. Further, in most cases, the valuation at which investment in the Company is significantly higher than the fair market value of the shares, thereby resulting in tax being levied on the Startup.

Currently, investment by Venture Capital Funds in Startups which exempts from the above provision of the Income Tax Act. With the Startup India Initiative, the same has extended to investment made by incubators in Startups.

Startups Eligible for Tax Exemption

It is important to note that not all startups are eligible for the tax exemption announced under the Startup India initiative. To be eligible for the startup tax exemption, the Startup must conform to the eligibility criteria for Startups mentioned in the Startup India Action Plan.

Further, Startup would be eligible to obtain tax benefits only after it has obtained certification from the Inter-Ministerial Board, setup for such purpose. The Inter-Ministerial Board setup by DIPP would validate the innovative nature of the business for granting tax-related benefits. Hence, the process for obtaining tax exemption for Startups could be time-taking and cumbersome.

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Frequently Asked Questions

Common questions about Startup India Tax Exemption.

Under the Startup India initiative, there are three major tax exemptions offered to eligible startups: 1) A three-year income tax exemption for startups, subject to non-distribution of dividends. 2) Tax exemption on capital gains if invested in Government-recognized Funds of Funds or in newly formed manufacturing MSMEs and startups. 3) Tax exemption on investments made by incubators in startups, above the fair market value of shares.

Startups that conform to the eligibility criteria mentioned in the Startup India Action Plan and have obtained certification from the Inter-Ministerial Board set up by DIPP (Department of Industrial Policy and Promotion) are eligible for the tax exemptions. The board will validate the innovative nature of the startup's business before granting tax-related benefits.

The three-year income tax exemption is aimed at helping startups grow and meet their working capital requirements during the initial years of operations. Startups often struggle with cash flow in the early stages as they work on turning ideas into commercially viable products or services.

The tax exemption on capital gains encourages investors to invest in startups and creates a vibrant investor community. This exemption is applicable if the capital gains are invested in Funds of Funds recognized by the Government or in newly formed manufacturing MSMEs and startups.

The tax exemption on investments above fair market value is crucial because, in most cases, the valuation at which investment in a startup is made is significantly higher than the fair market value of the shares. Without this exemption, startups would be taxed on the excess amount received over the fair market value of shares.

No, the process of obtaining tax exemption for startups may not be straightforward. It could be time-taking and cumbersome as startups need to obtain certification from the Inter-Ministerial Board, which will validate the innovative nature of their business before granting tax-related benefits.

No, not all startups are eligible for the tax exemptions under the Startup India initiative. Only startups that conform to the eligibility criteria mentioned in the Startup India Action Plan and have obtained certification from the Inter-Ministerial Board are eligible for the tax exemptions.

The tax exemption on capital gains, if the gains are invested in Funds of Funds recognized by the Government, helps increase the funds available with various Venture Capital firms and Angel Funds. This, in turn, provides better availability of capital for startups.

Currently, individuals can avail of capital gain tax exemption if they invest in newly formed manufacturing MSMEs and purchase "new assets" with the capital gains. By extending this exemption to startups and considering investment in "Computer or Computer Software" as the purchase of "new assets," the initiative aims to promote technology-driven startups.

Yes, the three-year income tax exemption for startups is subject to the condition that the startup does not distribute dividends during this period. This ensures that the startup utilizes the exemption to reinvest in its growth and operations.